Mar 24, 2004|
Engineering: What history says?
With Indian power sector expected to add another 40,000 MW in the 10th plan, improvement in the transmission and distribution (T&D) network backed by the APDRP scheme, both power generation as well as power distribution companies are likely in incur huge capital expenditure. In such a scenario, if one were to consider one of the biggest beneficiaries from such spending are engineering companies.
The growth of engineering companies is highly dependent on the level of private and public sector investment in the economy. When investments in capacities and infrastructure gains momentum, more jobs are created and demand for goods in general increases. This in turn leads to higher economic growth. Historically, the growth of the engineering sector has been sensitive to economic performance (as is evident from the graph above). The industry is relatively less fragmented at higher end, as competencies required are high. It is therefore that the barriers to entry are also high.
Lets have a consolidated picture of top <>engineering companies over last few years and see how things are likely to shape up going forward. It is always good to have a historical perspective when it comes to judging future performance.
As we can see from the graph above, companies have been able to grow their topline consistently over last three years and the trend is likely to continue for next five years backed by higher orders from the power sector. Operating margins are factor of two things, one is internal efficiencies (productivity per labour) and second, the quantum of new order bookings. Higher order book gives engineering companies a choice to select the projects that is likely to yield better margins.
Lower operating margins in 2001 is due to both of the above mentioned factors. Due to lower infrastructure spending, revenues were on the lower side and that was also one of the reasons for a sharp fall in operating margins because companies were ready to take whatever comes. And second reason for lower margins is that major companies like BHEL, ABB, Thermax were going through restructuring exercise wherein they have tried to not only rationalize the work force but have also exited from the non-core areas. So, the picture of engineering companies what we see today is much refined.
We believe that the topline growth should not be a problem for any of these companies. ABB, which is market leader in T&D equipments, is likely to grow on the back of investments in T&D areas of power (APDRP scheme). BHEL is likely to grow because of higher investments in the power generation (additional 150,000 MW by 2017). While Thermax, being a niche market player, is likely to grow because of higher captive power generation plants. Siemens is likely to witness growth in almost all segments like telecom, power and medical equipments. However, as the industry matures, operating margins are likely to stabilise at around 10% on broader basis. The graph above strengthens our view. Though there may be occasional spurts, margins are not likely to increase beyond 8% to 10% levels, which has been the international experience as well.
We would like to conclude by saying that engineering is a promising sector to be invested in, provided the investment horizon is more than 3 years. While we believe that some stocks already trade at the higher end of the valuation band and consequently are reflective of the medium term growth in profitability, it is wise to be selective. Like the software sector, not all companies have the ability to scale up operations and deliver returns consistently.
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