5 Apr 2022 , 02:12 PM
Some of the key industries showing healthy capex include energy (power generation, predominantly renewable and storage, transmission, oil & gas, green hydrogen), digitalization (including data centres), core industries (cement, metals) and corporate sectors (automotive/ mobility, pharma, chemicals, textiles, among others), the report said.
ICRA studied two samples of Capital Goods companies — the original equipment manufacturers (OEMs) and engineering and procurement companies (EPC) with captive manufacturing of engineered/ fabricated products. The revival of capex in various end-user industries resulted in strong order booking in the past fiscal which in turn has allowed order book to expand at the highest levels in last six years thus providing healthy revenue visibility with OB/OI ratio of 0.87 times for OEMs in ICRA sample as on December 31, 2021 (typical order tenure 6-18 months) and 1.85 times for EPC companies (typical order tenure 12-24 months) in the sample. While timely execution remains a key amidst uncertainties relating to any covid wave resurgence as well as supply chain disruptions, majority companies in the sample are likely to report healthy revenue growth in FY2022 as well as FY2023.
As per the recent report published by ICRA on Capital Goods, Mr. Sabyasachi Majumdar, Senior Vice President & Group Head, ICRA says, “While the order books have expanded appreciably in recent quarters led by both public and private sector capex across several sectors, uncertainties arising from factors like supply chain, geo-political tensions and any restrictions on account of Covid resurgence, could dampen order execution or future demand inflow. Further, the sector has been affected by a sharp increase in commodity prices especially crude oil, fossil fuel, metals as well as logistics costs (especially on exports) — and any significant relief from which is unlikely in the near term. This could adversely impact the operating margins of capital goods companies given the majority of contracts being fixed price in nature which restricts the ability to pass on price hikes to customers, despite revenue growth expectations.”
ICRA sample of OEMs remains net debt free and cash rich in light of lower working capital intensity involved in the business as well as relatively higher margins (partially on account 6-18month order execution tenure). Working capital intensity of OEMs sample displayed a consistent improvement in the past five years as against the EPC sample. Further, in the current fiscal when operating margins were facing headwinds from elevated commodity prices and freight cost for both set of players, with contacts being largely fixed price in nature, the contraction in margins for OEMs was lower than EPC companies, reflecting the benefits of value addition and product mix.
With relatively higher working capital intensity with funds blocked as retention money and comparatively lower operating margins (partially on account of service mix with segments exposed to higher commodity price risks, especially with order execution tenure being typically higher than one year) sees EPC samples carry debt in their books, resulting in moderated leverage and coverage ratios relative to their OEM counterparts. Moreover, with relatively greater contraction in margins of EPC samples in the recent past, it has been observed that these companies remain more vulnerable to changes in input prices as well as time and cost overruns.
Adds Ms. Anupama Arora, Vice President & Sector Head, ICRA, “Higher value addition (including calibrated localisation), improved penetration in end user verticals while building on diversification of product basket and geographies including emphasis on operations and maintenance (O&M) and after sales services/ refurbishment opportunities (predominantly by OEMs) while investing in capability building or partnering with global majors to penetrate newer segments are some of the strategies adopted by capital good companies that we observed. Additionally, consolidation (including bolt on acquisitions) to expand/ complement product basket/ end user/ geographies is also evident among the trends in the sector.”
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