Sector Update: Capital Goods

The Capital Goods sector is going through a prolonged phase of slowdown due to low capex spending, delay in execution process, stretched payments, high interest rates, land acquisition issues and a huge slate of stuck/stranded/un-operational projects.

Source: Ace Equity, BSE

The BSE Capital Goods index plummeted 51.9% (April 01, 2019- April 17, 2020 whereas, the Benchmark index was down 23.1% in the same period.

The bad phase for the sector is yet not over and has to go through severe pain impacted by the spread of Coronavirus (Covid19). The disease is widely spreading all over the world. In India, the total number of cases have crossed 13,800 mark and is expected to rise as no country in the world is able to find proper vaccine to cure the disease. The extended lockdown announced by Indian Government till 3^rd May 2020 may help to curb the disease but will affect the economic numbers and manufacturing activities in the country. The operational halt in the country will adversely affect the performance of the Capital Goods sector.

Near Term Challenges in the sector (3 months)

These immediate challenges to be faced are project delays, slippage in revenues/milestones, inflating cost, increase in receivables, deterioration in working capital, likely surge in debt, stress on cash flows and liquidity with regard to payment of salaries, contract workers and other hard fixed costs. Manufacturing/Construction activities are stalled during the lockdown, and only design & engineering services continue through the work-from-home mode. As most companies move into survival mode, order inflows in 1Q/1HFY21 may witness significant shrinkage, especially in the private sector.

Medium Term Challenges (12 months- 18 months)

Fight on who will bear the cost of short term challenges: The major question arises is who will bear the cost of lockdown? Will it be the Government, customers or the EPC/capital goods companies? It is likely that companies and customers will jointly bear the cost, wherein CG players with higher bargaining power may be able to secure a more meaningful compensation. Many mid-to-small size sub-contractors and suppliers may struggle to survive.

Delays, deferrals or cancellation of private-sector projects: The ability and willingness of private-sector customers to continue their capex plans may fall due to likely drop in consumption and utilisation levels. There is a risk of certain order inflows becoming slow-moving or non-moving for the next 6-12 months, or even cancellations in a few cases. Certain services too, or AMC contracts may witness deferment due to lower usage (in hours) of equipment/systems.

Worsening working capital for infrastructure projects: The domestic infra projects funded by state/central government may reel under the pressure of strained cash flows. However, post the pandemic, the government may draw on construction and infrastructure creation as a means to drive employment to the masses and to the bottom of the pyramid.

Growth Prospects at risk: For an already struggling investment cycle, the pandemic is a severe threat. Any significant long-term changes in consumption patterns seen post Covid-19 and capex sentiment remaining muted for over 12-15 months could result in significant deterioration in the growth outlook.

Make or break for “Make in India”: The silver lining post the pandemic would be diversification of some global supply chains to countries outside China. India could be a preferred partner in certain sectors like chemicals, automotive & engineering products, electronics and consumer durables. A supportive government policy framework and incentives can help attract FDI in the manufacturing sector in India, driving demand for Capital Goods companies in the coming years.

BSE Capital Goods Index Stock Performance