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Growth momentum in Indian industrial companies continued in 1QFY23, led by consumables and small industrial products, which were also able to sustain margin pressures owing to better pricing power and improved sales mix. However, projects and durable companies faced the brunt of slower pickup in sales and were unable to pass through cost increases. Aggregate sales of 47 industrial companies clocked growth of 47% YoY in 1Q23 (3-year CAGR: 8%). Key observations were: a) Consumables (abrasives, bearings, machine tools) and small industrial products (transformers, motors, compressors) reported healthy quarter (3-year CAGR: 13%), led by improved capacity utilisation and better mix (higher exports and aftermarket), b) export oriented companies (Cummins, AIA, GMM, Timken, Thermax, KEC) reported healthy order inflows with global capacity allocation by parent companies and US/EU customers looking at building local capacities, c) late cycle companies (BHEL, ISGEC, Thermax, Honeywell) faced challenges on higher input cost and slow execution, d) order inflow momentum remained strong and posted growth of 28% YoY, led by Voltas, Blue Star, Thermax and Techno Electric, in sectors like data centres, renewables, FGD, etc. Gross margins (ex-BHEL) continued to remain under pressure (-240 bps YoY, 33.3%), however EBITDA margins (ex-BHEL) expanded by 130 bps YoY to 10%, mainly due to low base. On a 3-year basis, only few segments have been able to improve margins like pumps, compressors, bearings and transformers. We maintain a positive stance on the sector with top picks being Bharat Electronics, Tega Industries, Data Patterns and Voltas.

* Observations during the quarter: Aggregate net sales witnessed a strong uptick of 47% YoY owing to low base, and also showcased better performance vs pre-Covid level, given continued momentum in economic activities. On 3-year CAGR basis revenue/EBITDA/PAT posted growth of 8%/4%7% respectively. The demand remained robust in both consumables (bearings, abrasives, and mining consumables) as well as small ticket industrial products (transformer, motors, pumps, compressors). However companies in EPC (power generation and T&D), gensets and consumer durable segment saw muted growth on 3-year CAGR basis, which was mainly pricing led, in our view.

* What companies are saying: Increased in allocation by government on capex in last budget on end segments like railways, defence coupled with central sponsored schemes such as PLI is likely to augur well for the sector. However, margins across board likely to remain subdued given inflationary pressure and adverse geopolitical conditions. Order inflows continue to remain strong from segments like renewables, water & waste water, warehousing, FGD and data centres. The cumulative order backlog for 1Q23 stood at INR 2,484 bn (7.0% YoY), while ex-BHEL OB grew 14% YoY to INR 1,485bn. Order book to TTM sales provides revenue visibility for 2.1 years. Order inflows were up 28% YoY and grew 90% vs 1Q21, while ex-BHEL it was up by 38% YoY, and surpassed 1Q21 levels by 92%.

* What surprised the street: Net sales for 15 of 27 companies beat estimates, while 7 companies reported in line numbers and 5 missed estimates. Moderate growth in majority of the companies was largely on the back of supply chain and logistic issues. In respect of profitability, 11 out of 27 companies’ beats estimates and this can be attributed to better execution with healthy exports and operating leverage benefits. Lower profitability in 16 out of 27 companies was given industry level challenges such as raw material inflation, higher logistic cost and delay in price pass on to end users.

* What we prefer: Our top picks are a) Tega Industries, to benefit given new product (DynaPrime liners) possessing USD 900mn metallic liner market for conversion coupled with 75%+ sales comes from repeat orders b) Bharat Electronics, steady growth in order book with improved execution profile, progressive ban on imports and new business segments, c) Data patterns to benefit from indigenisation drive in the defence sector and bulging order book across segment providing fair revenue visibility and d) Voltas, dominant position in Indian RAC market with increased focus on backward integration to push growth going forward.

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