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Sowmya Sundar

Stocks of many companies in the capital goods industry have doubled in value over the past one year.

A YEAR ago, there were few takers for engineering sector stocks. Stocks of companies in the capital goods industry were trading at low valuation levels, as investors appeared to ignore the sector. But, today, the same sector seems to be sizzling with stocks, such as Cummins India, Bharat Electronics, Alfa Laval, Bharat Forge, Thermax, Crompton Greaves, BHEL, Siemens, ABB, Kirloskar Oil Engines and Alstom Projects, doubling in value over the past one year.

Piggybacking on their success, even small-cap stocks — such as Carborundum Universal, Man Industries, Shanthi Gears, Praj Industries, Kirloskar Brothers, Honda Siel Power, Aban Loyd Chiles and Grindwell Norton — have gained sharply. The BSE Capital Goods index climbed 57 per cent in the last year, and is close to its all-time high. What has led to the re-rating of the engineering sector as a whole?

Domestic markets rev up

A series of developments, such as the mega road project, pick up in oil and gas exploration activity, surging automobile sales, power sector reforms and the outsourcing story, has lead a resurgence in business prospects and, consequently, interest in stocks from this sector. These developments triggered demand for infrastructure equipment, drills, rigs, power equipment, and turnkey projects. The spill over effect was felt across the lower layers of the sector, such as compressors, engines, machine tools and auto components.

Opportunities galore overseas

The success in exploring overseas markets and a number of foreign companies deciding to shift manufacturing partially to Indian companies opened up new vistas for MNC affiliates. Companies such as Cummins and Alfa Laval derived almost one-fourth of their revenues from export markets. BHEL, BEML, Thermax, Bharat Forge, Elgi Equipments and Engineers India saw the share of exports in the total turnover rising rapidly. Cummins India, Afla Laval and Ingersoll Rand emerged as a manufacturing hub for a number of products for group companies. Bharat Forge bagged outsourcing contracts from global manufacturers to supply auto components.

Another visible trend is the engineering companies shifting away from the traditional British and American markets to developing West Asian and East Asian markets. Recently, Engineers India achieved a breakthrough in Iran after bagging a prestigious refinery order, and Bharat Forge has established a foot-hold in China in the last year. The Chinese market contributes close to 37 per cent of its export turnover now.

But, interestingly, exports apart, the story for the year was the pick up in domestic sales. For most companies domestic sales also moved up.

Cleaning up the mess

During the recession, a number of companies, such as Siemens, Timken India, Thermax, Crompton Greaves and Alfa Laval, restructured their operations, cut flab and improved cost efficiencies in order to push up profitability levels. Over the last two years, they have emerged leaner and meaner organisations. Now that the external environment is conducive, a surging topline coupled with efficient operations has enabled engineering companies to post higher growth in profitability leading to the sector as a whole getting re-rated.

Time to book profits?

The power sector reforms are getting executive support. But it will still be some time before implementation gets into full swing and fill the order books of equipment makers.

At present, BHEL, ABB and Siemens are cornering industrial orders that have started flowing in as big companies go in for captive power plants to reduce costs.

The Central Government-sponsored Accelerted Power Development and Reform (APDRP) programme has not really taken off as expected. In this backdrop, the big wigs in the business may be in a comfortable position. But for the smaller players, it will take a while before they cash in on the opportunity.

The economic conditions do not offer any compelling evidence to believe that the growth could taper, especially with the industrial segment on an upswing and copious monsoon. Good news on orders, opportunities and profitability is still flowing in. To a large extent, the rally was also backed by foreign fund flows. If FII fund flows into the markets slow down, the valuations might take a hit.

Investors can stay with frontline engineering stocks such as Cummins, Bharat Electronics, BHEL, Bharat Forge, ABB, Thermax and Ingersoll Rand. But regular profit booking and re-entry at lower levels may be the wiser strategy. Profit booking should be considered in small-cap stocks if 30-35 per cent returns are made.

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