Investors lose faith on capital goods companies
Capital goods, a sector which investors felt was a sure shot way to riches in 2007, seems to be slowly falling out of favour, at least for the moment.
By Nishanth Vasudevan, TNN |
MUMBAI: Capital goods, a sector which investors felt was a sure shot way to riches in 2007, seems to be slowly falling out of favour, at least for the moment. The reason for this is the lower-than-estimated earnings of some companies in the March quarter, triggering some analyst rating downgrades and sparking concerns that the best of the sector may be over in the foreseeable future.
The anxiety is not about the companies��� order book position, which remain robust, but scepticism that they may not be able to meet project deadlines within the estimated costs. The sharp jump in raw material costs have already taken a toll on the sector���s profit margins in the quarter under review.
The anxiety is not about the companies��� order book position, which remain robust, but scepticism that they may not be able to meet project deadlines within the estimated costs. The sharp jump in raw material costs have already taken a toll on the sector���s profit margins in the quarter under review.
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Siemens, a power transmission equipment maker, said net profit in the quarter dropped 98% led by provisioning for anticipated losses on select power projects due to cost escalation pressures. Another engineering major, ABB, also posted lower-than-estimated earnings in the quarter, prompting Merrill Lynch to downgrad its ���longstanding buy��� rating on the stock to ���neutral���.
Earlier in April, Citigroup downgraded Bhel, one of the top Sensex performers in 2007, to ���hold��� from ���buy���, as the company���s provisional fourth quarter earnings showed a slowdown in order backlog execution and squeeze in margins.
���Our recommendation downgrade is not based on a fundamental deterioration of the underlying business. Rather, it is based on rationalising expectations to the view that there is limited margin expansion boost left and execution has to drive most of the incremental growth,��� the investment bank had said then. Most of the shares in the capital goods sector including Bhel, ABB, Larsen & Toubro and Siemens, are 30-50% off their early-January highs, also partly mirroring the broader market weakness. In 2007, investors had almost blindly bet on this, driving these shares up by over 100% during the period.
But it may not be all gloom for the sector. Many players who felt that market was valuing the sector unrealistically a few months ago, now are of the view that the current panic may have been over done. ���We were underweight on the sector before this correction, as valuations were much ahead of fundamentals, but now (after the correction), we are positive for the medium to long term,��� said JM Mutual Fund CIO, Sandip Sabharwal.
According to analysts, Larsen & Toubro, Bhel and ABB are currently trading at roughly 25-30 times 2008-09 estimated earnings. Prior to the recent correction, L&T was at over 45 times 2008-09 estimated earnings, Bhel at over 30 times and ABB at roughly 35 times.
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Mr Sabharwal said that the best purchases in shares are made when the mood is pessimistic, especially in a sector like capital goods, which is expected to grow steadily in the long run. Analysts expect these companies to report 30-40% growth in revenues over the next 4-5 years, led by government���s increased thrust on investments in infrastructure such as power, airports and roads. Morgan Stanley, in a report in October last year, said it expects investment of $48 billion in the power generation sector in India over five years.���The existing pessimism is on account of higher commodity (that are raw materials) prices, but these are cyclical issues. Anyways, they (commodities) are already overbought. The situation will improve in the medium term,��� Mr Sabharwal added.
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