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2-year CAGR depicts evident signs of recovery

Indian industrial companies registered a strong quarter post 2nd Covid wave, as aggregate sales of 42 industrial companies clocked growth of 24% YoY in 2Q22, while it grew by 6% CAGR over 2- year period, given healthy demand across domestic and exports. Key observations during the quarter were as follows: a) Consumables (abrasives, bearings, mining, machine tools) and small industrial products (transformers, motors, compressors) reported robust quarter 15%+ 2-year CAGR, led by improved capacity utilisation, better mix (higher aftermarket) and market share gain vs unorganised/cheaper imports, b) export oriented companies (Cummins, AIA, GMM, Timken, Thermax, KEC) reported healthy improvement in both sales and order inflows, which is partly led by China+1 sourcing strategy of developed nations, c) late cycle companies (BHEL, ISGEC, Thermax, Honeywell) faced execution issues and were also impacted due to higher input costs and supply chain disruption, d) order inflow momentum improved by 105% YoY (on a lower base), but remained flat on a 2-Year CAGR basis, led by BHEL, Thermax and Bharat Electronics, in sectors like cement, metals and petchem. Gross margins continue to remain under pressure (-160 bps YoY) despite price hikes taken to curb the impact and higher freight costs. However, operating margins improved (+140bps over 2Q21) given favourable sales mix and cost rationalisation measures during 2Q22. We continue to maintain our positive stance on government-led infrastructure capex, PLI scheme-led capex in multiple sectors, private sector capex cycle recovery amidst improved profitability and low interest rates and normalisation of export activities

* Observations during the quarter: Aggregate net sales witnessed a strong uptick of 24% YoY, owing to the resumption of economic activities with ease in lockdown. Ex-BHEL sales remained in the similar range (22% YoY) surpassing even 2Q20 levels by 17%. Latecycle companies in the power equipment, captive power, power T&D equipment and gen-set segments revenues fared well during 2Q22. The demand for mid-cycle/early cycle companies in bearings, abrasives, machine tools, transformers, motors and compressors continue to remain robust on both domestic and exports front, while EPC players like KECI, KPP and Techno Electric could have grown better, but faced intermittent COVID challenges at some projects, especially in overseas locations, and volatile raw material prices. BHE sales were robust on YoY basis, primarily on better execution.

* What companies are saying: Recovery in domestic demand, government impetus to infrastructure spending, export growth and the China+1 sourcing strategy of global players have led to strong rebound in businesses. Order inquiries have improved significantly largely from commodity linked sectors like metals, cement and oil&gas, etc. Government capex also improved in defence, roads and construction (buildings), but railways continue to lag. Ordering from commercial realty is gathering pace especially from data centres.

* What surprised the street: Net sales for 15 of 27 companies beat estimates, highlighting healthy recovery post Covid led lockdown in 1Q22, while 8 companies reported in line numbers and 4 missed estimates (mainly on the captive power and EPC front). In respect to profitability, 15 out of 27 companies’ beats estimates and this can be attributed to better domestic and export market coupled with high operating leverage. The biggest disappointments were witnessed largely on the captive power and T&D companies such as Kalpataru Power, Triveni Turbine, and Engineers India.

* What we prefer: Our top picks are a) Bharat Electronics, steady growth in order book with improved execution profile, progressive ban on imports and new business segment, b) GMM Pfaudler, prime beneficiary of structural tailwinds such as China+1 strategy in chemicals and pharma industries and market share gains led by top quality products c) Schaeffler India is best placed to benefit from a cyclical recovery and step up in annual capex by 2x in CY22/23 will increase localisation levels as well as increased dividend outgo ratio will be RoE accretive. d) Cummins India, robust export momentum with improved capacity utilisation levels likely to drive growth and elevate margins, going ahead.

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