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Engineering 2QFY10: Suzlon spoils the show - Views on News from Equitymaster

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Engineering 2QFY10: Suzlon spoils the show
Nov 17, 2009

Similar to the preceding quarter, the performance of companies forming part of the engineering and capital goods sector was quite mixed during the quarter ended September 2009. While some companies continued with their growth trajectory, few faced the effects of the economic slowdown. However, as compared to last year, the scenario in terms of order inflow has changed significantly with a handful of companies, especially the larger ones, witnessing an increase in such inflows during the September quarter.

A good number of companies that were impacted by the economic downturn are still trying to climb out of the slump. While the scenario has improved for the better, they are still getting impacted by lower sales volumes and the overall gloom of their clients' lower capex plans. This especially holds true for companies that are involved in niche businesses.

The operating performance of the sector has been quite mixed as well. While some companies were able to take advantage of the lower input costs, other faced execution issues which led to cost overruns. Some were even impacted on account of lower business volumes. While cost cutting measures are being made, not every company has been able to do it with ease.

One should also not ignore the tough competitive environment, especially for the equipment manufacturers. Further, interest costs have not really risen considering that the base figure (last year's interest costs) is quite high. However, considering that the sales have dropped marginally, they remain higher as a percentage of sales.

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

Performance* of capital goods companies
(Rs m) June-Sep 2008 June-Sep 2009 Change%
Sales 300,190 290,537 -3.2%
Expenditure 269,709 260,163 -3.5%
Operating profit (EBDITA) 30,481 30,373 -0.4%
Operating profit margin (%) 10.2% 10.5%  
Other income 7,338 7,457 1.6%
Depreciation 4,250 5,456 28.4%
Interest 4,009 5,416 35.1%
Profit before tax (PBT) 29,560 26,959 -8.8%
PBT margin (%) 9.8% 9.3%  
Extraordinary income/ (expense) -2,861 1,113  
Tax 9,611 10,166 5.8%
Profit after tax/(loss) 17,088 17,906 4.8%
Net profit margin (%) 5.7% 6.2%  
*Consolidated results for ABB, BHEL, Blue Star, Crompton Greaves, Emco, Elecon Engineering,
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 (similar to preceding quarter), we have compared the parameters of the above mentioned group by including and excluding its numbers.

Six out of thirteen companies reported growth in revenues. Leading the pack was BHEL, which reported a 24% YoY increase in revenues. As a whole, revenues of this lot dropped by about 3% YoY during the quarter. However, on excluding Suzlon's revenues (whose revenues dropped by about 31% YoY) during the quarter, the revenue growth figure of the group would stand at a mere 5% YoY. Companies such as BHEL, L&T, Voltas, and Crompton Greaves were the larger companies that reported year on year growth in revenues this quarter, while those like Suzlon, Punj Lloyd, Blue Star, ABB reported fall in revenues.

Moving on to the operating performance of this group, operating profits were lower by 0.4% YoY. The lesser decline in operating profits (as compared to the decline in sales) was on the back of 0.3% YoY improvement in operating margins. It may be noted that out of this group of thirteen companies, only five were able to expand their margins on a year on year basis (mostly on account of lower raw material costs).

But as these companies - BHEL, Blue Star, Crompton Greaves, L&T, and Voltas - are relatively larger in size, they have managed to influence the overall improvement in the groupís margins. The worst performer this quarter was Suzlon, which reported operating margins of 1.7% as compared to 8.9% during the corresponding quarter last year. If we ignore Suzlon in the overall groupís performance, then the scenario is very different. Operating margins in this case stand at 12.2%, leading to a 22% YoY increase in operating profits.

As compared to the 0.4% YoY decline in operating profits (22% YoY growth on excluding Suzlon), the profit before tax figure dropped by 9% YoY (18% YoY higher on excluding Suzlon) during the quarter. While other income increased by only 2% YoY, depreciation and interest costs increased at a much faster rate of 25% YoY and 35% YoY respectively. While depreciation costs stood at 1.9% of sales (1.4% last year), interest cost stood at 1.9% of sales (1.3% last year).

Again, on excluding Suzlonís performance, the scenario is quite different. In that case, the other income would be higher by about 8% YoY, while the rise in depreciation and interests stood at 20% and 35% YoY respectively. Depreciation costs stand at about 1.5% of sales (1.3% last year), while the interest cost stands at 1% of sales (0.8% last year).

The 5% YoY increase in net profits is mainly on account of the extraordinary adjustments. On excluding the same, profits are lower by 16% YoY. If we look at the same figure i.e., excluding the extraordinary adjustment without including Suzlonís results, then profits would be higher by 18% on a year on year basis during the quarter ending September 2009.

Conclusion
During the quarter, we did see some of the engineering majors getting impacted due to a concern that is very often overlooked Ė execution risks. We have been reiterating this time and again. While companies may go ahead and build up their large order books (thus assuring them of revenues for anywhere between 1-3 years, or even more in some cases), one should not forget the fact that being long gestation contracts, it is much more easier for them to get delayed as opposed to a smaller duration contracts as the uncertainty factors plays in. The chances of issues such as cost overruns, delay in financial closures, cash flow problems with customers, time overruns, problems with sub contractors, and delays in getting approvals are quite high. The engineering, procurement and construction majors - Punj Lloyd and L&T - were just some of the companies that were faced by such problems during the quarter ended September 2009.

As you may be already aware, the markets have risen quite sharply over the past few months. Same has been the case with the BSE-Capital Goods Index. However from the chart below it does seem that the result season may have given investors a reality check in terms of valuations, which still seem to be quite high. In the year till date, the BSE-Capital Goods Index has risen by about 85%. Presently the index is valued at about 27 times, which by any means exceeds our comfort levels.

Source : CMIE Prowess

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