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Execution and margin to be key monitorables

There has been a moderation in order inflows in 4QFY24 owing to the impending election cycle. However, for key verticals such as renewable energy, power T&D, defense, railways, metro and water, order inflows have been steady overall in FY24 thanks to the government’s continued thrust on capex. On the private side, investment activity has been selective, primarily in areas such as data centers, real estate, cement, metals & mining, industrial automation, and PLI-led capex. Green shoots are visible and the ordering momentum is expected to gather steam in the post-election period and is resulting in valuation re-rating for the entire sector. We believe that strong order books of the companies should provide healthy revenue visibility. We expect 15% YoY growth in execution in 4QFY24. Supply chain issues that had affected previous quarters may continue to weigh on execution over the next couple of quarters, with the Red Sea crisis being a key monitorable. We expect EPC companies – LT, KECI, and KPIL – to see a gradual margin expansion as their low-margin legacy projects are near completion. We expect product companies to pass on lower RM price benefits to end-users. As a result, we expect a ~32bp YoY contraction in EBITDA margin for our coverage universe. In 4QFY24, we estimate our coverage companies to report revenue growth of 15% YoY, EBITDA growth of 12% YoY, and PAT growth of 5% YoY.

Domestic ordering momentum sees moderation in 4QFY24

With elections around the corner, order upfronting was seen in 9MFY24. Consequently, 4QFY24 saw some moderation in domestic ordering. During the quarter, LT announced orders worth ~INR652b, BHE won ~INR78b, KECI secured ~INR58b, and KPIL acquired ~INR45b. Notably, BHE has outperformed its initial FY24 order inflow guidance of ~INR200b, with ~INR350b. Similarly, LT’s 9MFY24 domestic order inflows declined ~11% YoY, but it was because of a high base created by large hydrocarbon orders in 9MFY23. As per our interactions with management teams, ordering momentum is set for a healthy uptick after 1QFY25. In 4Q, order activity was mainly driven by areas such as defense, B&F, T&D, hydrocarbon, etc. Private investments have been taking place selectively in areas such as data centers, real estate, cement, metals & mining, industrial automation, and PLI-led capex, which is positive for ABB, SIEM, KKC, TMX, TRIV. The strong enquiry pipeline seen in 3QFY24 should start materializing in 4QFY24. For our coverage universe, we estimate 15% YoY growth in execution in 4QFY24.

Margin trajectory to be mixed in 4QFY24

EPC companies, LT, KECI and KPIL, had guided for a better margin performance in 2HFY24, given the delay in completion of legacy projects; however, they lowered the initial FY24 margin guidance by ~25-50bp. LT and KECI should witness a material improvement in margins in 2HFY25. On the other hand, we expect product companies to witness a mixed impact of strong demand and lower RM prices and hence expect them to pass on some RM price benefits to end-users.

Export weakness seems to have bottomed out

Product exports have been sluggish in most geographies, except the GCC region, due to factors such as inflation, geopolitical worries, and economic slowdown. As a result, export growth stood lower than expected for KKC, ABB, and SIEM during 9MFY24. However, we believe that weakness seems to have bottomed out, with India’s overall engineering exports growing by ~8% YoY in the Dec’23-Jan’24 period. Moreover, demand is expected to see a gradual improvement as these challenges ease going ahead. For EPC players, international ordering activity, especially in GCC, has been robust, with LT, KPIL and KECI bagging oil & gas, hydrocarbon and civilrelated orders from Saudi Arabia and UAE. The outlook for these geographies is sanguine as crude oil continues to trade above USD70/bbl. Governments in these countries have laid out a roadmap to pivot away from their dependence on oil, which augurs well for these companies in terms of opportunity pipeline.

Election schedule can have a near-term impact on inflows and working capital

We expect the election schedule to have an impact on inflows and working capital during 4QFY24-1QFY25 for companies focused on government capex, particularly in the EPC and defense areas. With the order upfronting and the geographical diversification seen for most of the EPC and defense players such as LT and BHE, we expect companies to focus on execution. We expect normalization in order inflows and working capital from 2QFY25 onward.

We remain positive on long-term prospects for the sector

We believe that there are enough levers for the capex cycle to sustain over the long term, despite near-term election-related disruptions. Consequently, a couple of quarters of moderation in government ordering activity cannot be ruled out. However, we are seeing green shoots in private sector capex, particularly from auto, cement, metals and PLI-led capex. Companies’ order books are already quite buoyant, which provides visibility for a healthy revenue CAGR. Strong demand and RM tailwinds are positive catalysts, some of which will have to be passed on by the companies. Exports have seemingly bottomed out, and we expect a gradual pickup from 4QFY24 onward. Higher oil prices and GCC infra spending augur well for EPC companies, which have a presence in the MENA region. We thus increase our estimates to bake in 4QFY24 inflows and lower RM prices and also revise our valuation multiples upwards to bake in expected improvement in private capex post elections.

Our top picks

ABB, LT, and KOEL remain our top picks in the sector. We expect ABB to be the key beneficiary of an improved addressable market for short-cycle orders from the private sector as well as transmission, railways, data center, and PLI-led spending. We expect LT to continue to benefit from both domestic and international spending, along with control over its working capital. We like KOEL because of its attractive valuations and as it has further scope of re-rating from current levels.

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