Key points
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The Q4FY2009 performance of the companies under our capital goods and engineering universe was a mixed bag. The top line growth of many of the companies (particularly smaller companies) fell in line with our estimates, however pressure due to slower execution or volume growth and lower realisation was visible in some cases. Larger companies (Bharat Heavy Electricals Ltd [BHEL], Larsen & Toubro [L&T] and Pun Llyod) reported stupendous growth in their top line, which led to a strong 31.3% growth in the top line of our universe. On the other hand decline in key material cost led to improved operating performance of the companies, which was better than our expectation in most of the cases.
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The financial cost across the coverage universe emerged as a key dent in the profitability of the companies. The rising interest cost on a year-on-year (y-o-y) basis was largely due to stretched working capital cycle coupled with higher interest rates.
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On order book front, while companies like BHEL and L&T displayed remarkable order inflows, Punj Lloyd and Thermax continued to see sluggish order inflow during the quarter. For mid-caps too the order inflow remained sedate for the quarter.
Outlook
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Recently, the capital goods space has seen significant re-rating on the back of expectation of improving business environment with the installation of a stable government in the country. A stable government could improve capital inflow and increase infrastructure spending. This in turn would give a fillip to stalled and new projects. Subsequent to which the capital goods companies could see improved order intake. However, in the near term (H1FY2010), we feel the earnings may display sluggish growth, which is already in the price, in our view.
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Further, we believe the key challenge for the companies to address would be their stretched working capital cycles. We believe with business environment getting more conducive, the companies under our coverage should start to claw back to earlier levels of their working capital cycles, which subsequently would ease the financial cost pressure and working capital debt for the companies.
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Our top picks in the sector are BHEL and L&T in the large-cap space, while in mid-cap space, we like Genus Power Infrastructures. In this note we are making some changes in our recommendations. We are upgrading our recommendation on Punj Lloyd to Buy. For Thermax our recommendation changes to Hold. We recommend investors to exit KSB Pumps, as its valuations appear expensive.
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