Capital goods: Preferring volumes or margins? - Views on News from Equitymaster

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Capital goods: Preferring volumes or margins?

Mar 31, 2009

The launch of Tata Nano has been well received by all. The vehicle has created a big hype and as a result of such, bookings are expected to fly off the charts. However, a few days back a leading business daily reported that dealers of Tata Motors' small vehicle have been offered margins of only 2% to 2.5% as compared to the typical dealer margins of 3% to 3.5% on the value of the bill. This is understandable considering that Tata Motors itself is expected to earn thin margins on the vehicle. The question is what would you do if you were an auto dealer? Would you go for an exclusive Nano dealership (considering that it is expected to sell like hot cakes) and work on lower margins? Or would you stick to selling other vehicles to protect margins? Engineering companies, whose businesses are dependent on oil and gas investments, may be in a similar situation. As oil prices have crashed over the past year, projects have become less viable for the oil and gas companies (those involved in exploration, production, and transportation of these commodities). As a result of such, order inflow for engineering companies has remained low on account of lower investments, coupled with the overall economic downturn. In addition, many projects have either been put on hold or have been shelved. A leading business daily recently reported that thirteen public sector oil and gas companies have planned capex to the tune of Rs 570 bn to be spent in FY10 itself. This amount would be invested on expanding supplies and building new transportation networks for oil and gas. Another piece of positive news is that the government is expected to spend only Rs 250 m, which translates as nearly 0.04% of the total estimated investments. As such there would be a lower possibility of deferment of this mega spending plan. As per the plan, ONGC will be investing nearly Rs 302 bn including an outlay of Rs 94 bn for its foreign arm ONGC Videsh. This amount will be largely aimed at E&P activities (exploration and production). IOC will be spending Rs 110 bn. In addition, Gail has estimated its capex budget to be at around Rs 56 bn, up by about 63% as compared to the capex in FY09, mainly towards developing pipeline capacities and in city gas distribution projects. Other public sector oil companies that are a part of the spending plan include Bharat Petroleum Corporation Ltd.(BPCL), Hindustan Petroleum Corporation Ltd.(HPCL), Oil India, Chennai Petroleum Corporation (CPCL), Bongaigon Refinery & Petrochemicals Ltd. (BRPL), Numaligarh Refineries (NRL), Mangalore Refinery and Petrochemicals Ltd. (MRPL), Balmer Lawrie and Biecco Lawrie. The above-mentioned development is positive news for companies providing related services such as E&P services, pipeline and pump manufacturing, amidst others. It will help increase their order inflow and subsequently their revenue growth for at least the next two years. However, it may be noted that a handful of companies have entered these segments (on account of their lucrative nature) in the recent past. This has led to a strong increase in competition. With order inflow being slow in the past few months, companies will be looking to increase their backlog by bidding for these projects. Aggressive bidding on account of increased competition could bring down margins for companies as the newer players may go all out to bid for projects. What remains to be seen is whether companies will go for selective bidding in order to maintain/ improve margins or bid strongly and compromise on margins to fuel growth.

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