Q1FY2010 Capital Goods & Infrastructure earnings review

• Top line growth boosted by large players: In view of the slowing execution of project companies (Larsen and Toubro [L&T], Punj Lloyd) and a dip in the volumes and realisations of the product companies (Crompton Greaves, Thermax), we expect tapering off of the growth momentum for the capital goods companies in the first quarter of FY2010. However, boosted by the performance of the larger players (Bharat Heavy Electricals Ltd [BHEL]), we expect the companies in our coverage to report a healthy 16.6% growth in their revenues for the quarter.
• Material cost cools off, fixed costs may negate some positive impact: With raw material prices having cooled off in the last couple of quarters, we expect the benefits of the same had flown in during the first quarter of FY2010. For most of the companies under our coverage we expect the material cost as a percentage of sales to decrease on a year-on-year basis. However, with slowing revenues the operating leverage may reduce thereby setting some of the gains derived from the decline in the raw material cost.
• Interest cost would continue to hurt profits: All companies have been reporting a sharp increase in the interest cost on the back of an increased working capital cycle and higher interest rates. We expect the trend to continue and the higher interest expense would continue to hurt the profits of the companies. Our universe of capital goods companies is expected to report a profit growth of 18.2% for the quarter and the growth would be high mainly due to a high profit growth expected from BHEL.
• Order inflows: On account of slowing private capital expenditure (capex), the order inflow for the capital goods companies has been sluggish, particularly for the medium-sized and small companies. The order inflow for BHEL and L&T continued to be relatively better. The order inflow for the companies catering to the power sector (BHEL, Crompton Greaves, Emco) is expected to remain buoyant 
• Outlook: Lately, the capital goods space has seen significant re-rating on the back of expectations of improving business environment (a stable government and improving capital flows) which has given rise to expectations of improved order inflows in H2FY2010. With the business environment getting more conducive, the companies under our coverage should start to claw back to the earlier levels of their working capital cycle, which would subsequently ease the pressure on their financial cost and working capital debt. Our top picks are BHEL, Crompton Greaves and Emco. 

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