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Activity remains strong in select pockets

During 2QFY26, the capital goods sector witnessed multiple positive developments: 1) the CEA pipeline with projects worth ~INR333b recommended by the NCT over the past three months, 2) MoD’s TPCR 2025 outlines 15-year sectoral needs, targeting annual defense spending of USD25-30b, and 3) benign commodity prices. In our recent reports, we highlighted two much-awaited defense orders, i.e., additional 97 Tejas Mk1A jets and RFP issuance for the QRSAM. Although the sector has seen positive developments, a broad-based revival in government and private capex is yet to be seen. For our coverage companies, we expect margins to contract ~50bp YoY in 2QFY26 mainly due to lower margin assumptions for product companies. However, sequentially, we expect a ~40bp expansion in margins. For 2QFY26, we estimate our coverage companies to report revenue growth of 15% YoY, EBITDA growth of 11% YoY, and PAT growth of 14% YoY. We maintain our view that valuation rerating for the sector is contingent upon a broad-based capex revival. We reiterate our positive stance on LT, Cummins India (KKC), and Siemens Energy in the large-cap space and Kirloskar Oil Engines (KOEL) and Kalpataru Projects International (KPIL) in the mid- and smallcap segments. In the defense sector, Bharat Electronics (BHE) remains our top pick.

Ordering momentum stable with large-size order wins

Ordering activity during the quarter remained strong yet selective, with traction seen across defense, power T&D, renewables, thermal, hydrocarbon, and buildings & factories segments. During the quarter, notable wins included two ultra-mega projects for L&T in the thermal and hydrocarbon segments, a significant contract from NPCIL, and large orders in power T&D, heavy civil, high-speed rail, renewables, and metals & minerals. HAL secured an INR630b contract for 97 additional LCA Mk-1A aircraft, while the Indian Army issued a tender to BHE for the QRSAM project valued at INR300b. ABB was awarded an INR1.7b order from Siemens Gamesa, Chennai, for the supply of 3.X wind turbine converters. During 2QFY26, BHE booked orders worth ~INR52b, KECI secured ~INR61.5b, and KPIL acquired ~INR27.2b. Supported by a strong order backlog and the expected finalization of pending pipeline opportunities, we estimate 15% YoY growth in execution for our coverage universe in 2QFY26.

Recent developments in the defense sector

The recently announced Technology Perspective and Capability Roadmap (TPCR) 2025 outlines the Indian Armed Forces’ future technology and capability requirements over the next 15 years spread across domains like land systems, aviation, maritime, space, cyber, artificial intelligence, robotics, electronic warfare, and unmanned systems. Further, the revised Defense Procurement Manual (DPM) 2025 aims to streamline approvals by reducing bureaucratic hurdles, which will help the armed forces maintain operational readiness with quicker access to equipment, repairs and ammunitions. The Defence Ministry is also encouraging private players’ participation in large projects and moving away from nomination-based tendering. During the quarter, L&T and BHE formed a strategic partnership to participate in the AMCA program of the Indian Air Force. The ongoing emergency procurement program and the expected DAC meeting in the coming weeks will be keenly watched in the near term, and the budgetary allocation for defense will be looked out for in the medium term.

Commodity prices remain benign

With commodity prices being broadly benign during the quarter, we expect EPC companies’ margins to remain flat QoQ, with management guiding for YoY margin expansion for the full year. Following the uptick seen in FY25, input costs have eased, creating a supportive backdrop. Notably, prices of aluminum/zinc/copper have eased 2%/1%/4% vs. Mar’25 levels, while HRC prices have remained stable. Product-oriented companies’ margins would be dependent upon the revenue mix. In defense, the margin outlook is supported by higher levels of indigenization and localization of critical components. We expect ~50bp YoY margin contraction in 2QFY26 for our coverage universe mainly due to a high base of margins for select companies like ABB and Triveni Turbine last year. Sequentially, we expect margin to expand ~40bp.

Export prospects building up for domestic players

Export performance is gradually improving for companies. Overall, engineering companies have shown their intent to ramp up exports in FY26 after cautiously evaluating export markets amid the current geopolitical situation. EPC exports are gaining from consistent global investments in grid expansion, modernization, transmission, renewables, and decarbonization projects, and we expect this trajectory to continue going forward. Defense export prospects have strengthened following NATO’s announcement to raise defense spending commitments. We will be watchful of the current geopolitical scenarios and overall export trajectory of the companies.

View: Selective stance continues

Our selective stance continues on the sector and we continue to prefer companies in T&D, renewables and defense sectors. We maintain our view that valuation rerating for the sector is contingent upon a broad-based capex revival. Companies that are growing at a high pace will remain preferred bets over the medium to long term.

Our top picks

We continue to prefer L&T, KKC, and Siemens Energy in the large-cap industrial space and KOEL and KPIL in the mid- and small-cap segments. BHE continues to remain our top pick in the defense sector.

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