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Awaiting a broad-based activity revival

During 4QFY25, Defense and Transmission emerged as key growth drivers for order inflows in the sector. However, a broad-based revival in order inflows was notably absent, especially from central government and private sector players. Defense sector approvals from the Defence Acquisition Council (DAC) and continued focus from the Ministry of Defence (MoD) emphasized the intent of the government on the Make-in-India initiative and expedited finalization of large-scale platforms. This ensures sustainable, long-term revenue growth for defense players. For genset players, as highlighted in our recent note, demand has started recovering sequentially, but it is still lower than last year owing to the high base led by prebuying. Hence, revenue growth of genset players will be driven by the pricing trajectory. For our coverage universe, we expect revenue growth of 16% YoY and PAT growth of 6% YoY. We believe that valuation re-rating for the sector is still some time away and will be driven only after a meaningful outperformance of capex, order inflows, and margins. We prefer players that have a well-balanced revenue mix, control over margins, and the ability to maintain or improve their growth profile going forward. We maintain our preference for LT, ABB, and KKC in the large-cap industrial space and BHE in the defense space.

Order inflows tracking estimates thus far

Ordering activity for companies so far has been in line with expectations, particularly for EPC players. During the quarter, LT bagged an ultra-mega order from QatarEnergy for setting up two offshore compression complexes; this order is likely to be worth USD4b. Assuming this, LT announced orders worth ~INR670b during the quarter. KECI secured ~INR49.5b, and KPIL acquired ~INR69.8b worth of orders. BHE won ~INR86.1b of orders in 4QFY25 vs. an estimate of INR140b. With fairly decent order inflows for the transmission companies as well as for LT, the focus should now be on the timely execution of the current order book. With strong existing order books, we estimate a 16% YoY growth in execution for 4QFY25 for our coverage universe.

Recent DAC approvals augur well for defense companies

In Mar’25, the DAC approved Acceptance of Necessity (AoNs) for eight capital acquisition proposals amounting to nearly INR540b. For the Army, the government approved AoN for the procurement of 1,350HP engine to upgrade the present 1,000HP engine for the T-90 tanks. For the Navy, the DAC accorded AoN for the procurement of Varunastra Torpedoes (Combat). Varunastra Torpedo is an indigenously developed ship-launched anti-submarine torpedo developed by the Naval Science & Technological Laboratory. DAC also accorded AoN for procurement of Airborne Early Warning & Control (AEW&C) Aircraft Systems to boost the Air Force’s capabilities. Along with this, the Cabinet Committee of Security (CCS) approved a deal to procure an advanced towed artillery gun system (ATAGS) for the Army at a cost of INR70b to enhance the operational capabilities of the Indian Army. Going forward, we expect the MoD to remain focused on strengthening the Indian Air Force (IAF) fleet’s strength too. The IAF has prioritized acquiring radars, combat aircraft, helicopters, and mid-air refuelers for FY25-26.

Margin performance to be mixed; commodity prices mounting

We expect the YoY margin improvement for EPC players to be driven by the completion of low-margin legacy projects. However, we would keep an eye on commodity price movements. The copper/aluminum/HRC/ prices, in particular, have moved up by nearly 9%/5%/6% QoQ during Jan-Mar’25. Most of the EPC players have fixed-price contracts for nearly 40-45% of the total order book. Hence, a sustainable increase in commodity prices is likely to hurt future margins. Product companies can pass on the commodity price increases with a time lag, and for the current order book, we expect ABB, Siemens, and Cummins’ margins to moderate sequentially.

Exports to gradually improve for product companies

Overall engineering exports for the country have started improving, and we expect this to reflect in exports of key product companies too. Companies are still evaluating how to increase exports in light of the current tariffs imposed by the US. However, defense companies are optimistic about benefiting from increased export opportunities to Europe as the nation looks for rearmament after the RussiaUkraine war. EPC players are already benefiting from opportunities related to renewables and renewable transmission projects, and we expect similar momentum to continue in 4QFY25 and beyond.

Valuation re-rating still some time away

We maintain our positive view on companies that have a balanced mix of domestic (across segments) and international projects. Segments such as railways, water, urban infra, and state transportation projects are yet to see meaningful improvement from current levels, while transmission, renewables, and defense are likely to remain on an uptrend. We would thus prefer companies to have a balanced mix of exposure toward high-growth and medium-growth segments and can maintain growth despite select segments growing at a slower pace. Valuation rerating for the sector will be driven only after a meaningful outperformance is seen on capex, order inflows, and margins.

Our top picks

We prefer players that are able to tide through this near-term volatility with a wellbalanced revenue mix, control over margins, and the ability to maintain or improve growth profile going forward. We maintain our positive bias for LT, ABB, and KKC in the large-cap industrial space and BHE in the defense space.

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