Macro trends suggest weak business momentum
We note that most macro indicators such as growth in freight traffic through rail, road & ports are still witnessing a weak business momentum after a spurt in the first half of this fiscal. While energy consumption through the power, diesel and petroleum basket has witnessed some revival in the past couple of months, the trend is unclear given the low-base effect—sustenance of this growth would be the key factor to watch. Although trends in some of these data points are volatile, the broad-based trend highlights a weak macro recovery.
Demand for base industrial products continues to be weak
In order to corroborate our hypothesis, we have been analysing quarterly revenue trends for the past 13 quarters for 51 industrial and infra companies having presence across 20 business verticals. Our analysis suggests that growth for short-cycle base industrial products has been weak, which corroborates our view that a recovery in industrial capex is likely to be back-ended vs. infra capex.
Demand for consumption products is also mostly weak
Our analysis suggests that demand for consumption linked to real estate such as home cables, lights & fans and air-conditioners are showing signs of fatigue after an initial pick-up post elections. That said, some consumption categories, especially linked to urban consumers, are registering a sustained recovery, such as in the passenger vehicles, scooters and paints segments.
Infra projects are witnessing early signs of a revival…
Lower order inflow growth during FY12-14 coupled with ongoing execution challenges on-the-ground were key issues impacting growth for infra projects so far. But, we note that sales growth of infra companies and government capex are witnessing early signs of a revival as can be seen from growth for construction companies, construction & mining equipment and roads segments. We note that execution challenges as well as working capital cycle issues persist, though they aren’t deteriorating further.
…but, we expect a gradual pace of capex cycle recovery
Based on our bottom-up analysis, we expect the sector to witness a cumulative order flow of $332 bn over FY16-18, implying a weak growth of 7-12% p.a. We believe that the Dedicated Freight Corridor, solar power, metro rail, roads, railways (civil construction) & defence are the key verticals which are likely to drive order flow growth in FY16-18. We estimate 76% of this capex (capital expenditure) to be implemented by the public sector, funding for which is not a constraint (contrary to the common perception).
Sector still expensive overall; prefer Voltas & Adani Ports
Despite an 18% correction in prices for the industrials sector in the last three months, we remain negative on most stocks under our coverage given their expensive valuations and potential of continuing earnings downgrades. We prefer Adani Ports & Voltas given their structural growth opportunities. However, the near term growth in both these companies is likely to be muted owing to weak traffic growth for the port sector as well as for the room AC industry. Exposure to Middle East is key risk for Voltas.
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