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MOSL: INDIA INDUSTRIALS-Reminisces from the past cycles; Pockets of recovery visible across sectors

India Industrials: Reminisces from the past cycles; Pockets of recovery visible across sectors; elections a near-term dampener

 

A strong set of 2Q19 earnings from our Industrials coverage has brought back the discussion on revival of private sector capex in India into the limelight. While the stage looks set for a recovery over the next few years, we believe the upcoming state and central elections could cause delays till 2Q20. Through this note, we analyze the last two cycles and put forward our views on the performance of the upcoming cycle and its impact over the next few years.

The Golden period of Indian Capital Goods (FY03-12)

During FY03-12, India witnessed its “Golden period” of capex, buoyed by strong domestic economic recovery and sharp increases in global commodity prices. In our view, the key domestic triggers included (a) spending by NHAI to kick-start the highway building program in the country, (b) the Electricity Act that de-licensed power generation enabling private sector participation in power generation, (c) higher oil demand with growth in automobile production, and (d) strong growth in housing demand.  During this period, significant capex was incurred in Power, Refining, Roads, Steel, Airports and the Cement sectors. The Industrial sector sales grew 23% CAGR, EBITDA grew 26% CAGR and PAT was up 28% CAGR during the same period (Exhibits on Page 3).

The Consolidation period (FY12-17)

Post the strong capacity additions during FY03-12, the core sectors comprising Steel, Cement and Power witnessed a contraction in capex over FY12-17, hit by (a) weak demand leading to low utilization in the core industrial sectors, (b) overleveraged balance sheet of manufacturers, (c) slowdown in lending from banks who were plagued with rising NPAs, (d) unviable power purchase agreement (PPAs) and fuel shortages in power plants, and (e) breakdown of the public-private partnership (PPP) model in infrastructure, primarily roads (See Exhibit 9). Consumption-oriented sectors like Auto, Pharma, FMCG, Consumer Durables/Electronics, and F&B continued to expand capacities as its end-market continued to grow. During the same period, Industrial sector sales were flat, EBITDA fell 4% CAGR and PAT was down 6% CAGR (charts on Page 3). With the new government at the Center in FY15, infrastructure capex in Roads, Rail, Urban Infra and Water revived, starting FY16 on higher government spending, which in turn pumped the economy.