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Engineering is a diverse industry with a number of segments. A company from this sector can be a power equipment manufacturer (like transformers and boilers), execution specialist or a niche player (like providing environment friendly solutions). It can be an electrical, non-electrical machinery and static equipment manufacturer too.
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The sector is relatively less fragmented at the top, as competencies required are high. But it is highly fragmented at the lower end (like unbranded transformers for the retail segment) and is dominated by smaller players. The user industries in broad terms are power utilities (generation, transmission and distribution), industrial majors (refining, automotive and textiles), government (public investment) and retail consumers (pumps and motors).
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Order book size determines the performance of the company in the short to medium-term. In order to bag big contracts, companies need to have a big balance sheet size and proven execution capabilities. They need huge working capital in order to execute bigger contracts, as initially they receive only part payment and the remaining comes as projects get executed.
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Tariffs that earlier offered protection to Indian capital goods manufacturers, have been removed. Import duties on a range of equipments have also been reduced. This coupled with the high cost of capital in India puts Indian manufacturers at a disadvantage against overseas competition.
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Power sector contributes the largest to the engineering companies' revenues. For instance, ABB and BHEL derive 60% and 72% of their revenues from supplying equipments to the power sector. And with the government planning to add large generation capacities in the eleventh (2007-12) five-year plan, the potential seems huge for the engineering majors. This is because, apart from the investment in generation capacity buildup, an equivalent amount is likely to be spent in the transmission and distribution space as well.
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Infrastructure is another key area of operation for major Indian engineering companies. L&T, for example, garners around 30% of its sales from infrastructure activities like engineering, design and construction of industrial projects and social & physical projects like housing, hospitals, IT parks, expressways, bridges, ports, and water & effluent treatment projects.
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The high global crude prices on account of growing demand has led to increased activities in the exploration and development space. This has helped the engineering companies in this space. More importantly, this segment of the engineering business has relatively higher margins than infrastructure, owing to more complex tasks involved.
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| Supply |
Abundant supplies available across most segments, except for technology intensive executions.
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| Demand |
Demand growth in this sector is fuelled by expenditure in core sectors such as power, railways, infrastructure development, private sector investments and the speed at which the projects are implemented.
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| Barriers to entry |
Barriers to entry are high at upper end of the industry as skilled manpower and technologies, and ability to fund large projects are a prerequisite.
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| Bargaining power of suppliers |
Bargaining power of suppliers is low because of intense competition. However, in technology driven high-end segments, suppliers have the upper hand.
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| Bargaining power of customers |
Bargaining power for technology driven segments is low.
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| Competition |
Majority of the companies compete in terms of pricing, experience in specific field, product differentiation and timely completion of projects. |
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FY07 proved to be yet another good year for the Indian engineering and capital goods industry. Strong growth in industrial and manufacturing industries reflected in the picking up of investment activities in areas like power, infrastructure and processes. The capital goods index recorded strong growth during the entire year, though with some blips during the months September and October 2006.
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The order books of almost all companies witnessed healthy growth. For engineering majors like BHEL and L&T, at the end of March 2007, the value of outstanding orders stood at nearly 3 times and 2 times respective FY07 revenues. In general, the growth in order book came from both power and industrial businesses. The companies were able to bag international orders. The topline of the engineering majors witnessed double-digit growth during the fiscal.
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While the industry continued the trend of cost cutting through reducing debt and restructuring operations and manpower rationalization, rising input costs dented pared the improvement in profitability. Sharp rise in costs of steel and crude on the back of buoyant global demand and inadequate supplies, was the biggest dampener to profit growth.
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The fiscal also witnessed majors like Suzlon and Crompton Greaves chart out aggressive acquisitions in the international arena. The major focus area for these companies was to fill in the niches by way of acquiring new technologies and clients and having a diversified geographical presence.
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World-class infrastructure has emerged as one of the most important necessities for unleashing high and sustained growth and alleviation of poverty in any economy. And with poor infrastructure to support other growth initiatives, the Indian economy continues to be a laggard when compared to its developing peers. From a policy perspective, however, there has been a growing consensus that a private-public partnership is required to remove difficulties concerning the development of infrastructure in the country. The realisation finally seems to be setting in. This makes the future of the Indian engineering sector extremely bright. Apart from highway development and construction and modernisation of airports, the potential for the sector lies in the oil and gas space, where high global demand has led to increased action in exploration and production activities. Considering these factors, we expect the sector to grow strongly into the future. However, scale and execution capabilities will be the key mantras for success for the engineering companies.
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Impetus given for growth of infrastructure and core industry in the last two budgets of the central government is expected to increase capacity utilisation of producers of coal, cement, iron ore and likely to increase demand for construction and mining equipments. Industrial growth and capital investment levels have improved and this will drive the growth in the coming years.
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The government's initiative to bring clarity to the power sector reforms is a welcome sign for the industry. More coordination between the Centre and states for infrastructure development is a step in the right direction. The Electricity Act 2003 has introduced a lot of reforms in the power sector. The unbundling in the sector will definitely boost private investment. PSUs like NTPC are expected to almost double their generation capacity in next few years, which is a good sign for the engineering companies.
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The shift in focus towards reducing T&D losses will further increase the order book size of the companies operating in this realm. With power generation and distribution looking up, power equipment companies can look forward to a promising future.
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Deregulation combined with high global demand for crude has led to a surge in exploration and production activities in India and globally. Also, there has been a radical change in the government’s approach to E&P (exploration and production) activities in the country. This thrust in development of new wells and improvement of output from old wells promises bright prospects for engineering companies
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Automation business has perked as the user industries started realising its benefits. With increasing competition among the power companies, the consumers will demand better quality and uninterrupted power supply. In such a scenario automation will play an important role. With the automation technologies gaining momentum, companies like ABB and Siemens will benefit a lot going forward.
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Capacity addition and de-bottlenecking exercise being carried by various industries like steel, power, refineries, chemicals etc is likely to provide a fillip to the industrial segment of the engineering companies.
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