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Comfortably placed

The capital goods sector is comfortably positioned, supported by: 1) strong order book providing healthy revenue visibility, 2) favorable commodity prices offering comfort to margins, 3) strong balance sheet that provides leeway for capex, and 4) favorable government policies, such as plans for emergency defense procurement, focus on renewables, and Make in India initiative. We will wait to see a broad-based revival in domestic and private capex, along with sustained momentum in order inflows, which would drive a re-rating of the sector from current levels. We expect a 14% YoY growth in revenues for our coverage universe. With an improved revenue mix and benign commodity prices, margins are expected to remain stable YoY. However, sequentially, we expect margins to contract, mainly due to the high margin base of defense companies. For 1QFY26, we estimate our coverage companies to report revenue growth of 14% YoY, EBITDA growth of 14% YoY, and PAT growth of 12% YoY. We reiterate our positive stance on LT, KKC, and Bharat Electronics in the large cap space and KOEL and KPIL in the mid- and small-cap segments.

Healthy ordering momentum during the quarter

Ordering momentum remained strong during the quarter, supported by healthy traction across the defense, power T&D, renewables, and B&F segments. The railways segment, which saw a slowdown in FY25, has started showing signs of recovery since Apr’25. Order inflows were strong in 4QFY25, and 1QFY26 has started on a decent note. During the quarter, LT bagged orders across the power T&D segment, as well as in water, buildings, and factories, announcing inflows worth INR150b so far. The Siemens consortium won a major order worth INR41b from the National High-speed Rail Corporation for the Mumbai-Ahmedabad high-speed rail project. In 1QFY26, BHE won ~INR73.5b worth of orders, KECI secured ~INR68.5b, and KPIL acquired ~INR71.5b. Backed by a strong order book and the anticipated finalization of pending pipeline orders, we expect execution for our coverage universe to grow 14% YoY in 1QFY26.

Emergency procurement to augur well for both private and public defense companies

The DAC has approved emergency procurement worth INR400b for the Indian Defence Forces. Key systems prioritized under the emergency powers include surveillance drones, kamikaze drones, loitering munitions, and various types of missiles and ammunition. These emergency powers ensure that equipment is received within strict timelines, helping to meet immediate operational requirements. This is the fifth such tranche of emergency procurement since 2019. 13 contracts worth INR20b under the emergency procurement mechanism have already been concluded. Additionally, DRDO has offered 28 indigenous weapon systems to defense forces for emergency procurement. These include weapons like rockets, missiles, grenades, and anti-drone missiles.

Margin likely to vary across sectors

We expect EPC companies to report sequential recovery in margins as improved momentum continues following the completion of low-margin legacy projects. After seeing an uptick, prices of key inputs have eased. Product companies are continuously focusing on high-margin areas, tech-led offerings, and deeper penetration in tier 3 and 4 markets, enabling them to benefit from better pricing. We expect margins for most product companies to be either maintained QoQ or improve based on the business mix. In recent months, zinc/ aluminum/copper prices have eased by 9%/8%/2% vs. Mar’25 levels, while HRC prices have risen by 5%. A sustained decline in commodity prices is likely to improve marginsin future. We, thus, expect ~10bp of YoY margin expansion in 1QFY26 for our coverage universe, while sequentially, margin is expected to contract ~370bp, mainly due to the high margin base of defense companies.

Strong opportunities in international markets

Export performance is gradually improving for companies, with expectations of further gains from increased exports to the US, Europe, and the Middle East. EPC players are already benefiting from opportunities in renewables and renewable transmission projects, and we expect a similar momentum to continue going forward. Overall, engineering companies have shown their intent to ramp up exports in FY26 after cautiously evaluating export markets amid the current geopolitical situation. Defense companies are targeting larger opportunities through the export of major platforms such as Akash missile, MRSAM, and defense control systems, where domestic companies have already established their product quality in domestic markets.

Valuations baking in improved capex spends

The Capital goods sector has already seen outperformance during the quarter on decent results and expectations of capex revival. We expect these valuations to be sustained only on continuity of order inflows as well as earnings momentum. Broadly, capex activity from private sector continues to remain weak. Along with this, defense sector has seen a re-rating on hopes of emergency procurement as well as on NATO’s new spending targets on defense and expectations that India would follow the suit. We expect these to be positive for defense sector as it widens the TAM on both domestic and international markets for defense companies. Valuations for transmission sector plays would continue to remain high on continuously improving market opportunities on T&D and renewable.

Our top picks

We prefer companies with a well-balanced revenue mix, control over margins, and the ability to maintain or improve growth profile going forward. We remain selective on the sector and maintain our positive stance on LT, KKC, and Bharat Electronics in the large cap space and KOEL and KPIL in the mid- and small-cap segments.

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