The Hindu Business Line : Capital goods wilt on industrial data

Capital goods stocks fell on Friday after a drop in industrial output numbers for May was announced. While the overall IIP growth for May 2008 plummeted to 3.8 per cent compared with 10.6 per cent in May 2007, the capital goods sector grew by just 2.5 per cent against 22.4 per cent growth reported in May 2007.

According to Goldman Sachs, the monthly growth momentum in industrial production fell by 0.9 per cent month-on-month versus the 1 per cent month-on-month rise in April. Growth in capital goods production was 11.4 per cent in April. The monthly momentum, however, picked up by 0.2 per cent month-on-month versus negative of 0.1 per cent month-on-month in April.

Major Players

According to Mr Vinod Nair, a sector analyst with Religare, a combination of a very high base effect and current higher interest rate regime might have worked behind a sharp fall in activity in the capital goods sector. “This was a little unexpected. Going forward, further hardening of interest rates may cause execution problems for some of the players in the sector.”

As of now, the book positions for the major players provides roughly a one-year lag time before serious slowdown kicks in, analysts said. Because of high base a year ago, the current slump appears a bit overblown, some commented.

IIP has been very volatile in recent months growing at 9.5 per cent year-on-year in February, 3.9 per cent in March, 6.2 per cent in April and then 3.8 per cent year-on-year in May. Goldman Sachs expected IIP numbers to bounce back in June. It said in a note: “Our full-year estimate of industrial growth remains at 7 per cent year-on-year,” the firm said.

Meanwhile, Emkay Global Financial Services said in a note that concerns on EBIDTA margins of EPC players (contractors) and equipment manufacturers (suppliers) were negated under the veil of ‘price variation’ clause.

Price variation

“We have surveyed project developers (essentially the clients of EPC players and equipment manufacturers) and our survey reveals that only 59 per cent of the respondents have ‘price variation’ clause of which 18 per cent of respondents have 100 per cent pass through. This clearly reveals the inadequacy of the ‘price variation’ clause to safeguard EBIDTA margins in the event of a prolonged period of high input prices. It also highlights the risk of further scope for downward revision in EBIDTA margins over and above the 100-300 bps revision factored in post Q4-FY08 results. Our stress test analysis, on assumption of another 200 bps drop in EBIDTA margins reveals, 9-32 per cent drop in FY-09E earnings for our engineering & capital goods universe.

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