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Engineering: Will the sun shine?

Jan 19, 2001

The Indian economy is estimated to grow by 5.8% in FY01, lower than the 6.4% growth witnessed in FY00. Industrial output is projected to grow by 5.5%, a far cry from the 8.1% growth recorded in FY00. It light of the above statistics it is not difficult to discern that the calendar year 2000 was a disappointment for the engineering industry as a whole.Higher oil prices have added to the sector’s woes. Higher investments in the power sector did not materialise. Added to that, the market frenzy for technology stocks, took a toll on the industry heavyweights’ valuations. But when the going gets tough, the tough get going. Realising the dire straits in which the industry was headed, a few of the industry players did try to find new avenues for growth. Let’s look at the diesel engines segment first, in which a bulk of well known companies operate.

The Diesel engine pie
SegmentCapacityUser industriesGrowthMain players
Small range2-20 HPpumpsets, agricultural machinerymarginalKirloskar Oil
Medium range20-300 HPtractors, construction, power generation,
small industrial applications
7.5-10%Kirloskar Oil, Greaves,
Simpson & Co.
Large rangeabove 300 HPcaptive power plants, large industrial
applications, IPPS, marine
10%Cummins, Hindustan
Powerplus, Wartsila NSD

The engines industry can be classified into three segments according to their relative Horsepower (HP). These include small range (2-20 HP), middle range (20-300 HP) and the large range (above 300 HP).

The small engines fortunes are linked to the fortunes of the agricultural production. Tractors form the main user industry. Drought in states like Gujarat adversely affected agricultural production and hence, tractor and small engine demand. To boost demand, companies had to take a hit on margins and sell at lower prices. As a result, Kirloskar Oil Engines, which dominates this segment, saw an 87% decline in net profit in quarter ended September 2000. The company’s turnover saw a 19% growth during the quarter. Since growth prospects of agricultural production are not too bright in the coming year as well, many tractor manufacturers have decided to scale down operations. Hence, it is unlikely that this segment will see much growth in FY02.

The 20-300 HP range i.e. the medium range saw a 7.5-10% growth in 2000, largely on account of growth in demand from services industries such as hotels, hospitals and the telecom sector. This segment is likely to maintain its growth levels in 2001. This bodes well for major players in the segment such as Kirloskar Oil, Simpsons and Greaves.

Beneath these performances lurk some other dangers as well. Small and medium engine manufacturers like Kirloskar Oil and Greaves are facing increasing pressure on two sides. Bigger manufacturers like Cummins are entering the small and medium segment for volumes. An even bigger risk for these companies will come post April 2001, when import barriers are lowered. Cheaper imports may then eat away a large chunk of their market and put pressure on their margins.

Though the large diesel engines performance in 2000 was better, it still left a lot to be desired. Cummins India, which dominates this segment, saw a marginal 3% growth in turnover, but its net profit improved by 25% over the quarter ended September 1999. With Cummins looking at increasing its presence across all segments, it too is susceptible to the import risks post 2001, especially in the small and medium range. On the other hand, the company is likely to eat away market shares from Kirloskar Oil and Greaves.

It was Wartsila NSD, which saw a huge jump in both turnover and profits (67% and 204% respectively). The company operates in the above 1 mega watt (MW) i.e. above 1000 HP segment. Though the performance of Wartsila is encouraging, it cannot be taken for granted. The mega range engine users are basically utilities and electricity boards. Their demand is usually not consistent and comes in fits and starts.

All in all, the diesel engines segment does not offer a lot of hope to the small and medium engine manufacturers. Even for larger companies, the outcome is largely dependent on the growth in power sector investments. Though the potential for this is huge, the past track record of the power sector is a dampener.

In order to add more value, as markets get more competitive, companies are looking at ways to improve their operational efficiencies and streamline their costs. The industry is upgrading its manufacturing systems and replacing old pneumatic control instruments with sophisticated electronic equipment. This is where companies providing niche value added services like integration between management functions and shop floor activities stand to gain.

One such segment is the Distributed Control Systems (DCS) in industrial automation industry. Tata Honeywell, ABB and Bhel are the three key players in this segment, which is growing at 15-18% annually. But this is only one of the segments. India’s current hardware to services ratio has been 60/40 as compared to a 30/70 ratio in the west. As hardware takes a backseat, niche services segment are likely to spring up. This will be an interesting segment to look out for in 2001.

Majors like ABB, Cummins India and Wartsila Diesel are also acting as consultants and maintenance experts for the power plants they build for their clients. They not only build the plants, but are also asked by clients to maintain it for life. Though these services comprise a very small portion of their turnover currently, but the potential for their growth is huge.

Apart from identifying new areas of operations, MNC’s like ABB, Siemens and Cummins also pruned their interest burden last year and are now vying to become global sourcing bases for their parent companies. On the other hand, government owned engineering behemoth Bhel is also looking to improve efficiencies by cutting manpower cost and entering into technological tie-ups with some German companies. There is also talk of disinvestment in the air. Though at this moment, it looks highly unlikely.

With the government looking keen to speed up power sector investments, there is hope that the next few years will give rise to demand for engineering components, power plants and T&D equipment. All of the above combined are likely to result in improved bottomlines and therefore valuations for the Indian engineering companies. However, all eyes will be on the post April 2001 era when import barriers are lowered. How the Indian companies manage to fight this will determine their staying power.

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