Engineering & Capital Goods - ECG Monitor - September'12 - Emkay

In this month's update on the Engineering & Capital Goods (ECG) sector, we have analyzed power projects effected by Coalgate issue along with our usual assessment of tracking trends in project tenders, project awarding, production statistics, etc.

Risk assessment of Coalgate projects

- Coal blocks notified by either CAG or MOC were expected to power 44.2 GW power projects in India - largely owned by private power utilities.

- Projects nearing completion - 10.8 GW or about 25% of the projects and valuing Rs474.4 bn. We ascribe low probability for significant delays in project commissioning

- Projects more than 50% complete - 4.2 GW or 9% of the projects valuing Rs197.7 bn. We ascribe moderate to high probability for delay in completion of the projects.

- Projects less than 50% complete - account for about 5.9 GW or 13% of the total projects and value Rs236.6 bn. We ascribe high probability for delay in completion of the projects with moderate probability of abandonment.

- Projects in initial stages or in planning stage - account for the bulk of the projects at 23.3 GW (53% of total projects) and valuing Rs765.6 bn. We believe that these projects exhibit a high probability of being abandoned if fuel linkage issues remain unresolved.

- Emkay universe affected by the above projects include BHEL (Rs115.4 bn), L&T (Rs34.5 bn), Punj Lloyd (Rs10.1 bn), Elecon Engineering (Rs809 mn) and McNally Bharat (Rs750 mn)

Key trends observed during the month

- Tendering activity remained luke-warm in Aug'12 (2nd successive month) - barring for issue of a large Rs210 bn tender by Railways. Number of tenders published during the month declined 10% MoM to 2,613 (lowest since Dec' 11) and grew marginally by 4% MoM to Rs212.1 bn in value terms.

- Sector-wise, we witnessed a sequential all-round decline in number of tenders for the second successive month. Only exception was thermal power, aided by low base in Jul'12.

- Order finalizations grew sharply by 117% MoM and 40% YoY to Rs122.4 bn (though remains lower than long term average) - driven by across the sector finalization. At the sectoral level, roadways, power distribution and mining witnessed the highest increase on MoM basis.

- Production trend was mixed during the quarters though largely decelerating. Deceleration was witnessed in high value capital goods equipment, power T&D equipment and in construction equipment. While low value capital goods equipments largely witnessed stable growth.

- After briefly rising in Jul'12, Emkay commodity price index declined by 0.7% MoM in Aug'12 (up 7.0% YoY). In fact, ex-cement, the indiex appears to have pleataued out.

- The outlook for domestic ECG sector continued to remain downcast with sustained downward pressure on valuations (trading at mere 1% premium to Sensex) and recommendations (proportion of Sell ratings continues to rise). Forward consensus earnings cut though was minimal at 0.8-0.9% in Aug'12.

Top picks from EMKAY ECG universe

- We maintain that stock selection should be purely driven by visibility, cash flows and ROIC of the business models. Few companies appear to be richly valued (on relative basis). These should be viewed in conjunction to strength of the business model. Our top picks in the ECG sector are (1) Larsen & Toubro (2) Cummins India and (3) Greaves Cotton.

- Larsen & Toubro - Strong order book cover with diversified business model and top quartile earnings growth amongst peers. We have Accumulate rating with price target of Rs1603/Share.

- Cummins India - Technology intensive business model with near-term earnings catalysts and ROIC of +40%. We have Accumulate rating with price target of Rs500/Share.

- Greaves Cotton - Though we expect muted earnings growth in near term, FCF yield of 8% gives reasonable comfort. We have BUY rating with price target of Rs80/Share.

Source : Equity Bulls

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