Indian Economy: Whither Capex and Cap goods stocks?

7 Aug 2023 , 10:38 AM

In this report, analysts of IIFL Capital Services try to collate all the data points on capex to try and judge whether the current momentum has legs on it, and if Capital goods companies — the stellar performers of the last 2yrs — can continue to outperform. Analysts of IIFL Capital Services conclude that near-term momentum can flag, but the medium-term looks good. Accordingly and considering the rich valuations of Cap goods companies, they prefer Defence sub-sector instead. They introduce Bharat Electronics into their top picks. 

Strong OP by sector, backed by order flow momentum: 

Capital goods companies have outperformed, and are very rich – are their valuations justified? Order inflows in the last 2 years have been very strong, and mostly from the central govt, plus newer segments like Renewables, EV, Data Centres, etc.

Can this continue in near term, is the question: 

But 4yr Cagr has not been inspiring, and only in FY23 did the aggregate YoY capex growth rate inch up above NGDP’s. Central govt’s and new segments’ capex will continue to be strong, but large-scale private capex is yet to pick up. Going by the volume growth in Q1 results, demand environment continues to be weak. Moreover, capex cycles are generally international; international macro looks a bit wobbly, given the possibility of a lag effect of monetary tightening in AEs.

But medium-term capex outlook strong: 

All-in-all, near-term upsides might be modest. However, domestic capex has several strong mediumterm drivers, so cap goods companies’ OP should resume after a lull. From a 12-month perspective, Defence looks more attractive, and analysts of IIFL Capital Services introduce BEL in their list of top large-cap picks. Indigenisation creating opportunities – BHE’s offerings can address one-third of the positive list items under Defense Indigenisation (opportunity ~Rs2trn over 5 years). At 6% of sales, BEL’s R&D is impressive; OB at 3.7x TTM sales gives strong growth visibility and finally, a net cash balance sheet is a plus. All this and 31% FY25 RoCE can drive re-rating from 21x PER and 17x EV/Ebitda.