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Capital Goods - Results Preview - Higher Commodity Prices to Drag Margins - Reliance Securities

Posted On: 2021-10-10 16:16:43 (Time Zone: IST)

The economic activity is back to normalized levels in 2QFY22, with a strong uptick seen in various leading indicators and healthy rise in COVID vaccinations. Projects' execution and supply chain also on track with laborers coming back to sites.

Most manufacturing facilities and project sites were fully operational during 2QFY22 after the lockdown and restrictions seen in some part of 1QFY22. We expect utilisation to have a normal level in 2QFY22, while the tendering inquiry has also picked up. Ordering activity picked up led by higher government spending in railways, roads, metro, power T&D and oil & gas space. However, private sector capex was muted but is expected to pick up over the next few quarters. While products companies are likely to witness a strong YoY performance on a low base, opportunity was lost for cooling products due to the lockdown in the peak season. The impact of higher commodity prices is likely to dent the companies margins under our coverage universe to some extent.

For defence sector, we expect healthy traction during 2QFY22. BEL's Karnataka plant was closed for a few weeks during 1QFY22 due to lockdown and supply chain issues which impacted LRSAM execution in 1QFY22. However, with normal operations in 2QFY22, we expect healthy execution.

For products companies, despite the several rounds of price hikes, margins are likely to remain muted owing to a sharp uptick seen in commodity prices; however, we don't see any impact of the price hike on demand. While the second COVID wave during 1QFY22 dampened the overall business sentiment, is likely to see a healthy growth in 2QFY22. Channel inventory of fans is high, as the peak summer season was impacted by the second COVID wave. The B2B lighting business continues to remain weak due to low ordering activities from the government and private players, while the B2C LED light continues its moderate growth trajectory. Current discounts and promotional incentives are slightly lower due to cost pressure on manufacturers. Overall enquiry level is healthy while footfalls are lower due to restrictions on entry to malls, whereby only fully vaccinated consumers are allowed.

We expect our Capital Goods coverage universe to report 11% YoY, 7% YoY and 12% YoY growth in revenue, EBITDA and PAT respectively in 2QFY22E. EBITDA margin is expected to decline by 40bps YoY to 11.1%.

Our View: While the second COVID wave with the resultant lockdowns in few states in Apr'21 and May'21 impacted the execution and demand revival in 1QFY22, we expect it should be compensated going ahead with the withdrawal of restrictions. The Indian economy witnessed a sharp recovery in the past few quarters, while the strong capex revival in capital goods sector is likely to continue ahead. We expect the consumer durable sector to see a strong demand revival going forward, along with a significant change in consumer preference for quality and branded products. Improving business visibility has transformed into earnings upgrade and valuation expansion for the companies under our coverage universe. To reduce India's dependence on foreign military equipments, the ministry of defence has identified 692 items for Indigenization and 'Make-II' list, which will benefit the defence companies ahead. The ministry of defence announced a second negative import list of 108 items, which are likely to provide a boost to Atmanirbhar Bharat and indigenisation in the defence sector, with active participation of public and private sectors.

Our Top Picks: L&T, Kalapataru Power and KEC International

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