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Engineering: Exciting prospects

Aug 12, 2004

The prospects of the engineering industry are strongly correlated to the economic activity in the country especially in core sectors like power, infrastructure, mining, oil. Engineering companies derive their demand from capacity creations in these core sectors. Apart from them several other sectors including the manufacturing sector, consumer goods industry, automotive and process industries further provide indirect demand for engineering firms. With investment cycle on an upturn, government's focus on improvement of infrastructure and capacity addition plans fructifying in various industries like metals (steel, copper, zinc etc), refineries, power and textiles, the engineering sector is likely to reap the benefits of this heightened economic activity.

On broader basis, the growth of engineering companies is highly dependent on the level of private and public sector investment in the economy. Specifically the power sector is one of the largest consumers of engineering equipment and it contributes significantly to the orderbook of engineering majors like BHEL, ABB, Siemens, L&T etc. In last one year, 6 power projects achieved financial closure and another 10 projects are likely to reach financial closure soon. In the recent budget, the government has made a special allocation of Rs 35 bn to provide financial support to the state governments to carry out reforms in the power sector.

Further in order to improve T&D infrastructure, the government has made provision of Rs 400 bn. An additional outlay of Rs 200 bn has also been provided to state governments for implementing the upgradation and modernization of sub transmission and distribution facilities. In addition, Rs 200 bn has been provided to incentivise states utilities to reduce the cash loss reduction.

Thus, we see that from a single sector alone, engineering companies are likely to witness a surge in orders. One needs to understand that such high Investments in power are indicative of the demand for power from other sectors and thus indicates an upturn in the investment cycle from various other industries, which directly or indirectly contribute to further orders for the engineering sector. Hence other engineering components like boilers, automation components or drives etc will witness growth in the demand in the near future. In such a scenario, we may witness healthy order books for even the smaller engineering companies.

If one were to observe the trends of the engineering companies on the stock markets we would notice that the markets have already rewarded engineering companies for their performance and their future prospects. If one were to compare the returns given by capital goods index and BSE-Sensex over last one year we find that Rs 100 invested in engineering index would have resulted into Rs 164 as compared to just Rs 135 by Sensex.

The capital goods index includes engineering companies like BHEL, L&T, Siemens, Thermax, ABB, Alfa Laval etc.

Having enumerated in brief the prospects of the engineering sector, we would like to reiterate our position that the sector has witnessed large investor interest in the recent past and investors need to keep in mind certain aspects before they go in for fresh investments in the sector. When it comes to selection of stocks, investors should keep in mind the following points:

  • Balance sheet size: It helps a company win larger contracts.

  • Orderbook size: It indicates a company's standing in terms of future revenues.

  • Valuations:The key ratio used when it comes to putting a value for an engineering company is market capitalisation to sales. One could also use the P/E ratio as a tool to further refine the selection process.

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