Buy selectively in the capital goods segment, stocks like BHEL, L&T down due to economic slowdown

Many stocks in the capital goods segment have been beaten down due to the slowdown in the economy over the past one year. The price of BHEL has dropped from Rs 365 to Rs 215 over the last one year, while L&T has fallen from Rs 1763 to Rs 1370 in the same period.

The ET Capital goods index is down by 21.8% during the last one year. With economic growth slowing down, to 5.8% for the March quarter, and no signs of recovery, there could be more pain likely in the coming days.

As per a CRISIL report, credit quality of the capital goods sector is under strain, as per a study of 50 capital goods entities (engaged in equipment manufacturing and construction). The main reason for this is that the working capital requirements of the sector have surged to a five year high.

This has happened mainly on account of the deferment of large capital investment plans since 2011-12. The resultant build-up in inventory and delay in release of payments by customers has led to a tight liquidity.

As per Nagarajan Narasimhan, Senior Director, CRISIL Ratings "Project deferment by customers resulted in a 15-per cent decline in order inflow for capital goods entities in 2011-12 over the previous year. The reasons for deferment in projects include demand slowdown, increase in project costs and interest rates, and lower cash flows"

As per a report by Emkay Global, the Engineering and capital goods sector has witnessed sharp cut in earnings estimates over the past 18 months with 2012-13 consensus earnings estimates witnessing a 25.4% cut since Jan'11.

"Stock selection should be purely driven by visibility, and cash flows of the business models," says Pritesh Chheda, Analyst, Emkay Global in a note to clients. His top picks in the sector are Larsen and Toubro, Cummins India and Greaves Cotton.