Capex cycle Recovery: Cautious but Hopeful

Highlights

The main overhang of general elections holding back capex is behind us

Capex cycle, particularly government-led spending, to start from Q2 FY20

Private capex to pick up towards the end of the current fiscal

Sectors such as road, construction, railways, defence, power T&D and water to see contract award resuming soon

India's capex cycle has faltered, and a recovery remains elusive so far.
A series of events such as the Goods and Services Tax launch, demonetisation after-effect, the introduction of RERA in the real estate sector, and the banking and NBFC crisis disrupted the game.
Of course, a slowdown in government functioning ahead of the general elections and political uncertainty played their part. Other cues such as volatile oil prices, currency depreciation and the bitter trade war added fuel to the fire.
A few of these factors are behind us. We also analysed post-results commentary by managements of engineering and capital goods companies in light of the March quarter results. We sought to find answers to whether a capex recovery is on the cards and if yes, which sectors are better placed.
What can drive a capex cycle recovery?
The major uncertainty surrounding the elections is over. A government with a convincing majority is seen to improve the investment climate.
Projects that had been on hold because of the elections should come up for bidding once the Cabinet takes shape. Companies are hopeful that the projects nearing the 2020 completion deadline or flagship ones such as the Renewal Energy Mission, Bharatmala, Namami Gange, Housing for All, Green Corridor (power T&D project) would be expedited and accorded priority.
While the investment climate is expected to improve, companies have highlighted that the funding environment is improving as the banking and NBFC crisis is easing. Moreover, equity markets are expected to remain supportive. This should help kickstart project execution, especially those which have been delayed by the liquidity squeeze.
A lower interest rate regime and RBI's soft policy stance should augur well for growth in capital investments, especially by the private sector.
Timing of revival
At its analyst meet, L&T sounded a bit cautious about order inflows in Q1 FY20 in view of the Model Code of Conduct. However, the conglomerate has maintained its order intake guidance of 10-12 percent growth for this financial year and is confident of surpassing that guidance on the back of a pick-up in infrastructure activities, post-elections.
Similarly, Thermax offered a positive outlook. "For the past 4-5 months, there has been a significant slowdown in the large industrial capex in the country. However, we expect the order momentum to pick up in the second half of FY20," said M S Unnikrishnan, MD, Thermax.
Like Thermax and L&T, most companies are expecting the capex cycle -- particularly government-led -- to resume from the second or third quarter of the current financial year.
When will private capex resume?
Government-led capex is only one part, but a broad revival in private sector capex is expected only towards the end of 2019-20.
In fact, L&T's management cautioned that the private sector is being selective and a revival may not start in FY20, considering NCLT cases, a spate of defaults and the liquidity tightness. Companies like Thermax have also highlighted issues such as excess capacity in many industries.
ABB India sounded a bit cautious about any uptick in growth, at least in the current quarter. “Markets have been soft for a long time now, particularly on the industrial side. There have been fairly fewer investments. We believe that the June quarter too will be difficult in light of the recent performance of automobile, FMCG and a few other segments. Beyond that, it is difficult to read and assess the implications of a big political event in the country at this point in time,” said Sanjeev Sharma, MD, ABB India, during its March quarter analyst conference call. The commentary was before the election results were out.
The assessment at engineering companies is that a major or broad-based private capex recovery may not happen soon. Investors will have to wait till FY20-end or early next fiscal to see any concrete signs of a revival.
Also, Corporate India may wait for more clarity from the upcoming Budget on the new government's policies, allocations and priorities. They may wait for announcements from key ministries to set their priorities.
Which sectors will lead the recovery?
Companies are unanimous about the pick-up in government-led infrastructure and construction sector spending.
"With the momentum set on infrastructure building, coupled with incremental tax revenues, the emphasis on investment in airports, rail, roads, water supply and distribution, expressway programmes, power availability and connectivity, oil and gas production and mass rapid transit system is expected to continue," said L&T in its outlook for 2019-20.
Roads are a priority and orders from this sector are expected to resume soon. Others such as construction of ports, capex in railways and defence could be next. Companies in the defence sector such as Cochin Shipyard, Bharat Electronics, Bharat Dynamics, Hindustan Aeronautics, GRSE and many others are sitting on an order book of 5-10 times their annual sales.
They are expecting execution to improve and deliveries to take place in the first and second quarters of FY20. However, L&T is sees some delay in defence projects getting government approval, following which the award of contracts should begin.
India Inc thinks that the Railways would step up on order execution, helping revenue growth. Firms such as IRCON, RVNL, RITES are sitting on outstanding orders of about 5-6 times their sales. KEC International's railway division reported a strong 76 percent YoY growth in revenues in Q4.
KEC said the work for about 10,500 km of railway electrification will be awarded in FY20 and is expecting to get orders of worth Rs 3,500 crore in FY20, up 21 percent, from this segment.
"I think going ahead, the sectors such as construction should pick up. Along with that, we are expecting railways, marine, oil & gas to pick up. Overall, in the current fiscal, the domestic industrial business should grow at the higher end of 10-12 percent," said Cummins during its investor call.
Cement is another area where companies are witnessing sustained demand. Thermax in its call said: "All cement companies are now setting up captive power plants and FY20 cement ordering should continue." While the order flow in the domestic oil and gas sector was mostly subdued -- except the one that was won by Engineers India -- it expects two major refinery orders to come by in the second half of 2019-20.
In the transmission & distribution (T&D) sector, KEC International's management has upped its sales growth guidance to about 15-20 percent for FY20 and expects predicts better T&D ordering post-elections.
According to KEC International, the projects pertaining to the Green Corridor worth Rs 14,000-15,000 crore will be finalised by July-end as the timeline for the completion is within 15-18 months from now.
GE T&D has taken a similar line on the opportunities arising out of the Green Energy Corridor project. It expects evacuation of close to 67,000 mw of renewable energy. On an immediate basis, it sees tendering of about 29,000 mw and orders worth of Rs 6,000 crore, possibly starting in Q1 of 2019-20.