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Short-cycle businesses brace for sharp revenue drop
Capex plays appear more vulnerable due to leverage and high working capital
* Short-cycle businesses set to witness plunge in order inflows / revenue over next six months: While we remain structurally positive on short-cycle businesses (ABB and Siemens) owing to their technological advantage, digitalization and automation theme, and robust balance sheet, we brace for the risk of order inflows and revenue plummeting in the near term. We note that ABB’s OB/Rev stood at 0.6x and that of Siemens at 0.9x at Dec’19 end. We expect order inflows to decline sharply in the 4QFY20/1QFY21 quarters and revenue to plunge in the subsequent two quarters. We expect short-cycle businesses to rebound sharply once the situation improves; however, it is difficult for us to predict recovery in timelines in the near term.
* Plant closures to weigh on Industrial Automation: Various manufacturing units across sectors, including automobile and cement, have suspended operations until mid-April owing to the COVID-19 lockdown. The suspension may be extended depending on the situation. The same has been cited as a risk factor by various business leaders across companies. In our view, such a move would weigh heavily on the Industrial Automation business and hence we have lowered our estimates for the same.
* Robust balance sheets provide comfort on strong comeback subsequently: A positive of such short-cycle businesses is their net cash balance sheets, which help in maintaining low fixed cost v/s that of highly levered players. Companies with stronger balance sheets would be able to ride out such uncertain times of cash flow mismatch.
* Continued preference for net cash balance sheets and low working capital cycle: Within our coverage universe, we prefer companies with net cash balance sheets and those with superior working capital (WC) cycles as they are relatively better placed. In comparison, companies with high leverage/WC may face shortterm challenges in cash flow management and require support from government agencies (for payment) or banks (for easing interest and principal payments).
* Low fixed cost businesses with high cash balances prove better off: In these uncertain times, as a part of stress testing, we have attempted to approach our coverage universe based on the balance sheet ability to absorb fixed cost. Siemens and ABB stand out as they have low fixed costs and the highest cash balances, thereby enabling them to absorb the shock from economic downturn, if any, for a considerable time. Also, their strong global parentage provides additional comfort to us. Thermax has relatively high fixed cost, which may require some addressing if the situation worsens. L&T has multiple levers to ride out the crisis situation; however, it is likely to witness the worsening of WC in the near term. Moreover, the development business, such as road, metro, and power projects, may require cash funding.
* Top picks: We have cut our FY20–22E earnings estimates across our coverage universe by 0–37% (refer to Exhibit 24). We believe L&T, ABB, and Siemens are better placed to navigate the current turbulent times. We maintain our Buy rating on L&T and ABB and Neutral rating on Siemens, Cummins, BHEL, and Thermax.
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