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Ventura Wealth Clients
6 min Read

The stock market is a place where perceptions meet realities. Unless, these forces move in a harmonized manner, markets witness wild swings; but they are not bad always. When reality turns out to be better than the collective perception, markets celebrate positive surprises and vice-a-versa. For instance, ever since the Finance Minister has announced the Budget 2021, the market perception about a set of companies—old economy stocks and cyclicals—has changed significantly.

The market went into the Budget with a perception that the government would walk a tightrope on expenditures. Contrary to this belief, the government expanded its spending target not only for FY22 but also hinted that the pre-COVID fiscal trajectory can be achieved only after FY26. The implied meaning is: the government’s focus will be on supporting growth until then.

As a result, cyclicals have been rallying relentlessly. Interestingly, many FMCG and engineering companies now quote at similar P/E multiples on trail earnings.

Well, we need to understand the backdrop here.

FMCG companies have been riding on tailwinds for quite a few years now and have undergone a series of upgrades. As against that, cyclicals and old economy stocks have borne the brunt of tough economic conditions during the same time period. But now that the government is willing to pump more money into the economy, their earnings outlook has improved substantially.  

Experts call this a new-bull market or a re-rating phase for cyclicals and old economy stocks.

How dependable/reliable is this argument?

Let’s go back a decade and a half for cues

Between 2003 and 2007 the Indian economy grew ~8% every year. Indian markets had a dream run and cyclicals glittered since infrastructure development was a hot theme. A whole host of sectors participated—banking, construction, power and metals, to name a few. L&T was the poster boy of India’s infrastructure story.

L&T reported new order inflows of Rs 13,259 in FY04 and its market cap was Rs 7,100 crore at the end of the financial year. It touched Rs 80,000 crore in FY08 and the company’s new orders (for that year) jumped to Rs 42,561 crore.

In contrast, between March 2015 and December 2020, the company’s market cap grew at a compounded annualized rate which was lower than that offered by a bank on savings account balances. Lower economic growth was one of the biggest macroeconomic drags on the stock.

And this isn’t a one-off case. Take another example.

In FY04, Thermax’s chairperson Anu Aga was thrilled to announce the company’s then ‘highest ever’ new order wins during the year. The stock had rallied from low-teens in 2002 to ~Rs 70-75 in 2004. Between FY04 and FY08, the company’s stock witnessed a 10-fold jump and its new annual order inflows in FY08 were upwards of Rs 4,100 crore.

Thermax: New order status…

Note: 9MFY21 new order position of the company is Rs 3,286 crore against Rs 4,546 crore in 9MFY20
(Source: Company records)

You see, the economic upswing not only enhanced the company’s order book but placed its earnings in an uncharted territory.  

By no means, does this suggest that you should expect a similar performance from engineering companies in this so called new cycle. The only point you may drive home is earnings of cyclical companies don’t grow in a linear manner, like that of FMCG companies. So, all ratios - P/E, P/B etc., can change quickly.

December quarter performance is encouraging and the guidance is strong too

Q3FY21 earnings of some of the leading engineering and capital goods companies suggest that, the revival of business activities has been strong sequentially. Although not all of them have posted stellar numbers, they have been decent enough in most cases.

Report card of engineering and capital goods companies

 (Source: ACE equity)

In the quarter gone by, L&T has reported a 60 bps (Basis Points) rise in its EBITDA margins on a Year-on-Year (Y-o-Y) basis. However, its net working capital as a percentage of sales has increased from 23.5% to 26.2%.

Note: The red line in the chart above represents the 10-week moving average while green and pink represent 30 week and 60 week averages respectively

Although new order inflows in the first three quarters of the current fiscal have been 3% lower as compared to those during the same time period in FY20, in Q3 new orders are up 76% Y-o-Y. Although some of it could be on account of the loss of economic activities in the previous quarters due to the pandemic, it certainly hints at a pickup in spending during the quarter gone by. L&T has guided that Q4FY21 order inflows could be encouraging as well.

In the case of Thermax, new orders dropped 3% Y-o-Y. However, energy division which contributed 75% to the company’s revenue in Q3FY21, reported an impressive 62% jump in the new order inflows. The company also reported a 4% drop in its order backlog, which is a positive.

In the post-earnings briefings, the company has stated that it has a strong pipeline. Companies belonging to sectors such as steel, cement and tyres, amongst others, have been looking to expand capacities. According to company estimates, 30% of its orders are worth less than Rs 5 crore. This implies the company isn’t relying only on large orders, which often expose companies to concentration risk.

Another important highlight of the post-earnings briefing was the response of the management to the question on India’s proposed National Hydrogen Energy Mission. Ashish Bhandari, MD and CEO of Thermax, termed India’s hydrogen mission as a very positive development and stated that the company has a lot of products that fit in the larger scheme of hydrogen.

In the last few weeks the stock has witnessed a strong price-volume momentum.

Note: The red line in the chart above represents the 10-week moving average while green and pink represent 30 week and 60 week averages respectively

Energy and smart infrastructure businesses of Siemens witnessed a drop sequentially and also on a Y-o-Y basis. Siemens reported a 28% jump in its Large Drives Applications (LDA) business on a Y-o-Y basis; its LDA revenue has grown 22% Q-o-Q as well.

Relatively smaller companies, such as Kalpataru Power Transmission Limited and ITD Cementation India Limited, have also reported impressive performance. Kalpataru Power continued to deleverage its balance sheet with net debt going down by Rs 1,099 crore in Q3FY21 on a Q-o-Q basis.

 ITD Cementation has indicated that urban infrastructure, Mass Rapid Transport Systems (MRTS) and airports will be its focus areas now onwards. The company believes the water and waste water treatment segment could potentially become a high growth space. Strong parentage and relatively unleveraged balance sheet bode well for ITD. As on December 31, 2020, the company’s debt to equity ratio was 0.5 and its net worth was Rs 1,014 crore.

Note: The red line in the chart above represents the 10-week moving average while green and pink represent 30 week and 60 week averages respectively

A word of caution

Quite often, order backlog slows the pace of new orders. Companies that go in an upcycle with lean balance sheets and adequate capacities stand to benefit if their ability to secure orders is high and their execution track record is impeccable.

In Summary…

Macro economic developments, management commentaries of leading companies and the on ground activity, such as companies announcing capex plans etc, hint at a probable upswing in the economic cycle. That said, the benefits of upcycle won’t percolate automatically to all engineering, capital goods and other infra companies. Be selective!

Please Note (read as a disclaimer): None of the stocks discussed in the article are recommendations to buy, hold or sell. This could just be the starting point for deeper analysis that you might want to carry out on your own. You may also take professional help as you feel appropriate.

If you are investing in any family run company, besides governance, you may also want to take stock of significant developments in the lives of the promoters. Sometimes, their personal life can overshadow market sentiments. Also pay attention to issues such as pledging of shares by the promoter group and the working capital.

You may also like to read: In conversation with Nilesh Shah



We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

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