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Exports continue to shine, margin pressure building up

After subdued performance in Q122, industrial companies (ex-BHEL and GETD) are likely to grow by 18% YoY and 24% QoQ in 2Q22E. Eliminating the low base effect, we notice the 2-year CAGR stands healthy at c.7%. This robust growth is led by increased pickup in central government spends in defence, roads, etc. with healthy growth momentum in exports.

Consumer durables (VOLT, BLSTR, DIXON, AMBER) are likely to witness +29% YoY revenue growth, given softer base, however, 2-Year CAGR likely to be around 12% largely attributed to strong revenue growth in Dixon Technologies. Healthy demand on exports front, coupled with healthy production across industries will drive a 25% YoY growth for consumables – bearings (SKF, SCHFL, and TMKN). Order book led businesses in niche segments – defence (BHE, COCHIN) and T&D (TECHNOE) to see flat YoY growth. Late-cycle companies like BHEL, GETD, KOEL, KKC and TMX shall clock 53% YoY growth mainly on account of better order orders and improvement in exports.

Order inflow momentum to continue, led by FGD, chemicals, data centres, factories and smart-cities. Ex-BHEL and GETD, gross margins shall dip to 34% (-130bps YoY) led by sharp increase in commodity prices and EBITDA margins shall decline to 12% (-80bps YoY), largely on account of lower gross margins. We expect PAT to increase c.14% YoY for the sector (ex-BHEL and GETD). Our top picks are Bharat Electronics, Blue Star, Cummins India and KOEL.

* Growth trajectory to remain stout: We expect sector sales growth of 31% YoY and 18% YoY (ex-BHEL and GETD), led by steady recovery in automotive, commodity up-cycle driving production across steel, cement and larger industries and ordering from consumption driven industries such as pharma, FMCG and chemicals. Within airconditioning, we expect higher growth given soft base for all the 3 players in our coverage i.e. Voltas’s UP division (+44% YoY), BLSTR’s UP division (+18% YoY) and Amber (+53% YoY), however, revenues in UP division to decline marginally for BLSTR and 28% for Amber vs Q2FY20 due to weak consumer sentiments towards discretionary spends and extended rainfall in some pockets of the country.

Dixon is likely to see a strong growth led by ramp up in new customers and low base. Engine companies are likely to see a healthy growth led by both power-gen and industrial engines. Export data too indicates a strong momentum. Ordering momentum will likely to continue in select segments like defence and civil orders for metro rail, factories and smart-cities.

* Margins to decline given impact on gross profit: Gross margins for the JM universe (exBHEL and GETD) is likely to see a decline of 130bps YoY to 34%, as sharp increase in commodity prices will offset any favourable mix benefits. Improvement in gross margins will be witnessed in SKF India and Schaeffler India given better product mix and healthy exports sales. EBITDA margins (ex-BHEL and GETD) are likely to decline by 80bps YoY to 12.3% and growth is likely to be in the range of 10-12% YoY.

Decline in margins is on account of rising commodity prices and higher freight costs coupled with normalisation of expenses like travelling, advertising, rentals, etc. Dixon is likely to see a margin dip (-170bps YoY) due to higher share of mobile revenues while Amber, BLSTR is likely to see a decline on account of increase in RM cost and increased freight cost. AIA Engineering is likely to see sharp decline (c.430bps) because of a increase in ferro chrome prices and elevated freight cost. We expect PAT to increase c.14% YoY for the sector (ex-BHEL, GETD).

* IIP, engineering exports and other indicators remain healthy: In Aug-21, IIP (+12% YoY), IIP manufacturing (+10% YoY), IIP consumer-durables (+8% YoY), IIP mining (+24% YoY) and IIP electricity index (+16% YoY) displaying a meaningful recovery post disruption in Q1FY22. Exports in engineering goods have witnessed a healthy growth of 76% YoY and 43% over Apr-Aug’21 which is faster than import growth. Strong surge in export of iron, steel, ferrous, non-ferrous metals, transport equipment and machinery are leading in exports. Cement, steel, automotive, consumer-linked industries and freight movement remains buoyant. IHS Manufacturing PMI remained high at 52.3 in Aug’21 vs 52 in Aug’20.

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