Capital Goods: Risk-reward gradually turning neutral

26 Feb 2024 , 11:14 AM

Except for short cycle distribution driven products, rest segments of IIFL’s Capital goods universe continued to held strength in execution, profitability and end market demand. Thrust on completion of infra projects domestically continued ahead of election with steady cash-flows to companies, aiding NWC reduction; but new large projects witnessed slower ramp-up. Exports which were soft on global inventory destocking and weakness in developed market, is showing signs of bottoming out. Earnings upgrade was strong for KKC, marginal for ABB, BHE & APR after a robust beat while downgrades seen in KECI, KPIL, CGPOWER, TMX, DATAPATT. Amidst rich sector valuations, KKC, BHE, ABB continue to provide comfort on risk-reward. 

Earnings accelerates, inflows mixed: 

Aggregate IIFL CG universe’ revenues/Ebitda/PAT growth of 16/16/26% was broadly on expected lines. Domestic execution was healthy amidst moderation in growth for short cycle portfolios (base effect + impact from commodity prices). Inflows were robust at 28% YoY led by multi-bn$ project wins by L&T, steady inflows for BHE and other diversified industrials; but mid-cap EPC and short-cycle orders saw weakness (CGPOWER, KECI, KPIL). 

Key hits & misses:

50% of coverage reported in line results with notable earnings surprise from ABB and KKC, wherein favourable revenue mix, benign input prices and operating leverage drove earnings upgrade. BHE’s cost discipline and mix aided 12% beat, despite revenues slippages. L&T’s 3QFY24 inflows momentum (+30% YoY) surprised with robust order wins from Middle-East (HC & Infra) despite tardy domestic order finalization. Midcap EPC (KECI, KPIL) found relief from QoQ softening in finance costs and NWC cycle though inflows trailed L&T. Optimism for T&D value chain strengthened with turn in the power cycle. 

Risk to earnings increase on elevated expectations: 

Analysts of IIFL Capital Services cut FY24/25 EPS by 11/7% for TMX, 4/7% for KECI, 12/8% for KPIL, 5/3% for CG power and +4/-25% for DATAPATT, while upgrade of 8/4% seen in KKC, 5/1% in BHE and 1/2% for ABB. Analysts of IIFL Capital Services struggle to find value across coverage amidst elevated valuations and near term uncertainty from General Elections.