Time to capitalise on capital goods: 3 top stock bets | Economic Times

The Sensex and the Capital Goods Index were around 20,000 in January 2008. While the Sensex is at a much higher level now, the Capital Goods Index has not moved much. Massive capacity addition by Indian companies during the boom of 2005-08 is the main reason for this underperformance. As the economy did not grow as expected, these excess capacities remained in the system. After burning their fingers, companies became more prudent about capacity addition. Instead of large green field expansions, they moved to incremental capacity additions – either through brown field expansions or through de-bottlenecking and productivity improvements. The capital goods segment, which thrives on capital expenditure, thus languished.Experts say the time is now right to bet on the capital goods sector. After underperforming the Sensex for 13 years, the sector is showing signs of revival due to several factors. Domestic manufacturing is slowly picking up thanks to the Production Linked Incentive (PLI) scheme. PLI focuses on import substitution and helps domestic manufacturers reduce cost of production and increase competitiveness. Barring the auto sector, revival is happening in most sectors like speciality chemicals, electronics, food processing, medical devices, pharma, renewable energy, telecom, textiles, white goods, etc. The government is also incentivising domestic manufacturing by imposing or increasing customs duties. Experts say the capex cycle will follow with a time lag—after 1-2 years.Structural change, triggered by covid, is also helping domestic manufacturing. For example, global conglomerates are diverting part of their Chinese purchases to other countries. “Due to the China + 1 policy, international supply chain market is opening to Indian companies. This, coupled with PLI, is reviving domestic manufacturing and resulting in traction for capital goods companies,” says Anil Sarin, CIO - Equities, Centrum Wealth.The Capital Goods Index is inching upSince this revival is happening after years, this may be a good investing opportunity for the next 2-3 years. 85123786Huge capacity build-ups earlier were based on debt. When it failed, companies scrambled to reduce debt. This is the next reason why private sector capex was not picking up. It explains why investments as a percentage of GDP contracted in the past four years, despite increased government spending on infrastructure. However, private capex may pick up now because most corporate balance sheets have been cleaned and they are in a position to think about the next level of capacity additions. Due to a buoyant equity market, raising equity capital is easy now. “Investment cycle usually takes time to kick in, but once started it sustains for three to four years. India getting into capex mode can drive order inflow for the capital goods sector,” says Mahesh Patil, CIO, ABSL AMC.What to do nowStock market discounts well in advance and investors should act quickly. The Capital Goods Index has done well in the recent past. Experts say this is a long term story. “If you take a three-year plus view, cyclicals like industrials, capital goods, etc are good because they are bouncing back after a long time,” says Patil. While large players have moved up, some mid-cap companies are still at attractive valuations. 85123795Engineers IndiaSince lockdowns did not impact the oil and gas sector, its negative impact on Engineers India was limited. This Navratna PSU is the market leader in hydrocarbon turnkey projects. Since its current order book is around 2.6 times its 2020-21 revenues, there is clear revenue visibility. Strong balance sheet is another advantage. “RoE of Engineers India is expected to trend high due to lean balance sheet and free cash flows, which are set to be positive,” says a recent ICICI Sec report.Kirloskar Oil EnginesThe company has done well in the recent past due to the government’s increased focus on infrastructure development and Atma Nirbhar Bharat. Due to a strong pick-up of end-user demand, analysts also expect double-digit revenue growth in the next few years. With monsoon progressing smoothly, its agricultural pump set division is expected to do well. Due to increased activity in mining, its diesel engines for construction and earth moving equipment are also expected to do well. Triveni TurbineDespite fewer new power plants being installed, Triveni Turbine could restrict the weakness due to its unique space—it is the market leader in steam turbines up to 30 MW. To cut costs, more and more companies are resorting to co-generation of power—running steam engines with the help of heat released from manufacturing process. This process also helps the environment. Though Triveni Turbine’s valuation is on the higher side, experts feel it is justified. “The company’s strong margin profile, lean working capital, healthy cash flows, balance sheet and long term growth prospects will support its valuations,” says a recent Prabhudas Lilladher report.