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Engg: Too soon to call it a 'turn around'? - Views on News from Equitymaster

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Engg: Too soon to call it a 'turn around'?
Aug 17, 2009

Companies from the engineering and capital goods space put up a mixed performance during the quarter ending June 2009. While some showed less signs of a slowdown, few were literally gobbled up by it. As a whole, the sector still continues to face problems of slow order inflows. This was very much evident in companies whose business largely depends on industries. Many companies were also affected by lower realisations, especially equipment manufacturers. The reason behind the same is the tough competitive environment. However, what was heartening was the fact that quite a few companies were able to improve their margins by lowering their operating expenses on a year on year basis. There were many factors for the same, with lower raw material costs being the key one. However, while the operating performance of companies was mixed, one thing was quite common amongst the sector, especially the heavyweights Ė high interest costs.

In order to gauge the financial performance of some of these companies, we present herewith a combined June quarter ending performance of eleven of them and our analysis of the results.

Performance* of capital goods companies
(Rs m) Apr-June 2008 Apr-June 2009 Change
Sales 236,075 263,134 11.5%
Expenditure 210,890 241,033 14.3%
Operating profit (EBDITA) 25,184 22,101 -12.2%
Operating profit margin (%) 10.7% 8.4%  
Other income 6,972 7,502 7.6%
Depreciation 3,674 4,985 35.7%
Interest 2,530 5,149 103.5%
Profit before tax (PBT) 25,952 19,470 -25.0%
PBT margin (%) 11.0% 7.4%  
Extraordinary income/ (expense) (1,938) 10,166  
Tax 8,373 7,846 -6.3%
Profit after tax/(loss) 15,641 21,790 39.3%
Net profit margin (%) 6.6% 8.3%  
*Consolidated results for ABB, BHEL, Blue Star, Crompton Greaves, LMW,
L&T, Praj Industries, Punj Lloyd, Suzlon, Thermax, and Voltas

Before we look into each parameter separately, we would like to mention that as Suzlon Energy had an exceptional quarter we have compared the parameters of the above mentioned group by including and excluding its numbers.

Six out of eleven companies reported a growth in revenues. Revenue growth of this lot (as a whole) grew by about 12% YoY during the quarter. However, on excluding Suzlonís revenues (whose revenues grew largely on account of the REPower acquisition) during the quarter, the revenue growth figure of the group would stand at a mere 8% YoY. One interesting point that can be pointed out is that majority of the large companies were able to able record a revenue growth during the quarter. These include Ė BHEL, Crompton Greaves, L&T, Punj Lloyd and Voltas. On the other hand, engineering majors such as ABB and Suzlon (standalone) reported a sharp fall in revenues during the quarter.

Coming to the operating performance of this group, operating profits were down by about 12% YoY, while operating margins contracted by 2.3% YoY. Again, this performance was largely influenced by Suzlonís poor operating performance. The company in fact posted a loss at the operating level. On excluding the same, this groupís operating profits grew by 11% YoY while operating margins expanded by 30 basis points to 10%.

Six out of these eleven companies were able to expand their margins during the quarter. Reasons behind the same were various Ė lower raw material costs, lower other expenditure, lower employee costs, lower costs of traded goods, amongst others (all as percentage of sales).

As compared to the 12% YoY decline in operating profits (11% YoY growth on excluding Suzlon), profit before tax dropped by one fourth during the quarter. This was in spite an 8% YoY growth in other income. The main culprit for the same was higher interest costs, which increased to nearly 2% of this groupís sales as compared to 1.1% during the corresponding quarter last year. Depreciation costs also increased from 1.6% of sales during the quarter ending June 2008 to 1.9% in the quarter ending June 2009.

The 39% YoY increase in net profits is mainly on account of higher extraordinary income, which was largely contributed by L&T. (sale of stake in Ultratech Cement). However, on excluding the extraordinary items (the total amount) in both the quarters, profits have fallen by about 35% YoY. The reason behind the higher fall in profits (as compared to profit before tax levels) is higher tax outgo.

If we exclude Suzlonís entire quarterly performance and also the total extraordinary items of the remaining group, the growth at the net profit level would stand at 9% YoY for the quarter ending June 2009.

Conclusion
Managements of most of the engineering companies have mentioned that the business activities have been picking up when compared to the previous few quarters. Majority of them have mentioned that enquiries have started to increase. However, at the same time, there are few companies who are quite unclear about the outlook and when things are expected to improve.

Believing that the worst phase has gone behind, the market has started showing signs of optimism. While it may be a little too early to call it a 'turn around', we still believe that companies from the capital goods and engineering sector could face many issues in the short run, with the key one being execution. Plus, also looking at how volatile and unpredictable the business environment has gotten, taking a call on the short term can be quite tricky.

As mentioned above, the market seems to believe that the scenario is likely to improve from hereon as the BSE-Capital Goods Index has risen by about 120% since 9th March 2009. In the process, valuations of stocks have gone for a toss. The index is currently valued at about 24 times its trailing twelve month earnings, which by any means is not attractive.

BSE-Capital Goods Index: Rising on hopes?
Data Source: CMIE Prowess

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