Corporate Earnings: All Roads Lead to One

Kiran Dhawale

Understanding The Reasons Behind The Economic Resurgence 

In the infrastructure sector, road transport plays an important role. The Bharatmala Pariyojana, is targeted at building 34800 km in Phase-1 at a cost of Rs 5.35 tn,,of which 6,320 km length of road worth ~Rs 1.44 tn has been awarded. Another 10,000 km at a cost of Rs 2.5 tn will be awarded by December 2018. In FY18, the average road length constructed per day hit around 27 km and the ministry has set an ambitious target of 45 km for FY19. 

The Sensex earnings for Q1FY19 grew by ~3% on a YoY basis, whereas BSE Capital Goods index earnings grew by 48% during the same period. 

In the recent past, we have witnessed green shoots in the economy. For FY18, Indian economy posted 6.7% YoY growth, in line with consensus estimates of 6.6%. IMF’s growth forecast for India is pegged at 7.3% for FY19 and 7.5% for FY20. 

What is more encouraging is that the multiple data shows pick-up in the economy. For instance, the gross fixed capital formation (at constant prices) accelerated by 14.4% during Q4FY18 driven by 9% growth in capital goods. During FY18, capacity utilisation picked up from 71.2% during Q1FY18 to 75.2% in Q4FY18, indicating strong demand and tightening of capacity as well. This concurs with pick-up in core inflation above 6% level during Q1FY19. 

This trend could accelerate further as indicated in the PMI numbers and commercial vehicles' production, which has increased by 68% in Q1FY19. Professional forecasters expect the capital formation to GDP ratio to improve to 29% in FY19 and to 29.5% by FY20 at the current prices and the forecast also indicates core inflation to reach 5.7% in FY19 and 4.9% in FY20. 

We consider L&T as the forerunner of capex cycle and the current order book stands at Rs 2.7 trillion, 2.2x of FY18 revenues. The domestic order book alone accounts for 77% of L&T’s overall order book and it covers 2.5x of FY18 domestic revenues. The Government of India’s budgetary allocation for FY19 is ~Rs 6 tn and CMIE’s capex database on new project announcements for Q1FY19 has reached Rs 2.32 tn, which is higher than the previous three quarters. 

In the infrastructure sector, road transport plays an important role. The Bharatmala Pariyojana, is targeted at building 34800 km in Phase-1 at a cost of Rs 5.35 tn,,of which 6,320 km length of road worth ~Rs 1.44 tn has been awarded. Another 10,000 km at a cost of Rs 2.5 tn will be awarded by December 2018. In FY18, the average road length constructed per day hit around 27 km and the ministry has set an ambitious target of 45 km for FY19. With banks shying away from funding private infrastructure projects and few takers for BOT projects, the government has shifted gears to the hybrid annuity model (HAM). Under the HAM, the government pays 40% of the project cost during the construction period and 60% as annuity after the road is built. HAM accounted for only 10% of the NHAI projects in 2015-16, but in 2017-18, it accounted for half of the projects and it is expected to increase further to 60%. 

The capex by Indian Railways for FY19 is pegged at Rs 1.4 tn. A large part of the capex is devoted to capacity creation Under the freight plan, DFC is progressing well, where the current status looks optimistic with 97% of the contracts already been awarded. Contracts worth ~Rs 1.5 bn are in the final stages of clearance. 

On urban transportation segment, metro rail plays an important role. It is estimated that ~425 km of metro rail systems are already operational in cities of Delhi, Noida, Gurugram, Kolkata, Mumbai, Chennai, Bengaluru, Hyderabad, Jaipur, Lucknow and Kochi. This apart, another ~684 km is under construction in various cities. A new Metro Rail Policy was announced in August 2017 which will give boost to private investments by mandating public private partnership (PPP) component in the new projects. A new committee to lay down standards for metro rail systems was approved in June 2018. Metro rail projects worth over Rs 500 bn are underway in India and this pile is expected to grow. 

On airport infrastructure, the government is set to spend ~Rs 4.5 bn for revival of 50 under-served airports and airstrips, including those belonging to the Ministry of Defence. 

On shipping infrastructure, under Sagarmala project, the government is estimated to spend ~Rs 8.7 tn and projects worth ~Rs 2.4 tn have been already awarded. 

On the industry front, automobile sector alone could be spending ~Rs 580 bn in terms of capex over the next two years to transit to BS-VI and augment capacity for growing demand. Observations from M&M and Escorts indicate tractor industry growth to be 10-12%, which reflects pick-up in the rural economy. This could push consumption spending that could feed into the virtuous cycle of higher capacity utilisation by consumption-based sectors, which in turn could trigger capex requirements. 

We believe India is at an inflection point. The country’s median age is ~27.9 years and the dependency ratio is about to fall below 50% in a year or two, which will drive the household expenditure for decades to come. However, skill employment and productivity gains are important factors to benefit from demographic dividend. 

A slowdown in capex cycle was reflected in the quarterly earnings of S&P BSE Capital Goods, which earlier peaked in Q4FY11 and took 23 quarters to cross the previous level. Bloomberg estimates for BSE Capital Goods index earnings indicate that in the next nine months, the same could grow by 52% on a YoY basis. On a full year basis, earnings CAGR could reach 8% between FY12-19E. 

A pick-up in capex will boost corporate earnings, not only for the capital goods sector, but for the wider corporate space as well. This should support a leg-up in equity markets, owing to the bullishness of the capital goods sector 

Rajiv R Ranjan ,
CEO , Karvy Stock Broking.
Rajiv is Certified Management

Accountant - CMA and has been associated with
Karvy for more than a decade.

The capex by Indian Railways for FY19 is pegged at Rs 1.4 tn. A large part of the capex is devoted to capacity creation. Under the freight plan, DFC is progressing well, where the current status looks optimistic with 97% of the contracts already been awarded. Contracts worth ~Rs 1.5 bn are in the final stages of clearance 

A slowdown in capex cycle was reflected in the quarterly earnings of S&P BSE Capital Goods, which earlier peaked in Q4FY11 and took 23 quarters to cross the previous level. Bloomberg estimates for BSE Capital Goods index earnings indicate that in the next nine months, the same could grow by 52% on a YoY basis. On a full year basis, earnings 

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