India: Q3 Review of the Capital Goods Sector

The BSE Capital Goods index has been at the receiving end of negative activity, year to date. The index is down by nearly 64% from its 52-week high as compared to the BSE Sensex, which is down by 54%. In this article, let us have a look at how a few of the sector companies have performed during the quarter ended September 2008 on an aggregate basis

It’s the bulging order books of these companies that have helped them grow their topline in a strong manner. However, the high interest rates and the rupee volatility (forex losses) have impacted the profitability of most capital goods sector companies.

We have consolidated and compared the September quarter results of thirteen capital goods sector companies on a YoY basis. The topline for this consolidated group has increased by a worthy 32% YoY. But on a QoQ basis, i.e. in comparison to 1QFY09, the growth has been relatively lower. The topline in the previous quarter had increased by 38% YoY.

Performance* of capital goods companies

(Rs m)	July-Sep 2007	July-Sep 2008	Change%
Sales	206,080	272,576	32.3%
Expenditure	179,780	244,118	35.8%
Operating profit (EBDITA)	26,300	28,459	8.2%
Operating profit margin (%)	12.8%	10.4%
Other income	7,821	6,257	-20.0%
Depreciation	2,703	3,527	30.5%
Interest	2,238	3,537	58.0%
Profit before tax (PBT)	29,180	27,652	-5.2%
PBT margin (%)	14.2%	10.1%
Extraordinary income/(expense)	118	(2,861)	-2527.9%
Tax	9,142	9,017	-1.4%
Profit after tax/(loss)	20,156	15,774	-21.7%
Net profit margin (%)	9.8%	5.8%

* Consolidated results for ABB, BHEL, Blue Star, Crompton Greaves, Jyoti Structures, LMW, L&T, Praj Industries, Punj Lloyd, Suzlon, TRF, Thermax and Voltas; Minority interest and share in profit & losses of associates have been ignored for the purpose of comparison.

Coming to the operating margins, the same witnessed a 2.4% YoY contraction during the quarter. Higher raw material costs were the main reason for the quicker rise in expenditures. This led to the operating profits to rise at a slow rate of 8% YoY. During the quarter, there were very few companies that were able to improve their operating performance on a YoY basis.

From the above table, we can notice that the profits before tax have dropped considerably. This has been mainly on account of lower other income and higher interest costs. Interest costs have increased by 58% YoY in absolute terms. But as a percentage of sales, they increased to 1.3% as compared to 1.1% in 2QFY08. Depreciation expenses, on the other hand remained flat at 1.3% (as a percentage of sales), during the quarter.

On the bottomline front, the consolidated numbers are lower by 22% YoY. During the quarter, almost all the companies with exposure to exports or foreign currencies were impacted by forex and derivative losses (extraordinary items). A part of the drop in profits (as compared to the PBT) was also due to higher tax outgo, which increased to 32.6% in 2QFY09 as compared to 31.3% in 2QFY08.

What to Expect?

We have time and again mentioned that while companies have built up huge order books in the past few years, execution of the same will be the key going forward. And this especially in tough times such as the present. In the short term, companies will find it difficult to acquire funding due to the ongoing liquidity crunch. While the central bank and the government are making efforts to inject liquidity into the system, we believe that this situation will still take some time to ease out.

However, all said and done, we expect companies to benefit from increased infrastructure spending in the country over the long term i.e. over the next 3 to 5 years. As for the short-term, it remains to be seen how things play out.