Capital goods companies, comprising engineering, procurement, and construction (EPC) service providers (excluding road and civil construction) and manufacturers of equipment, will see revenue rise a healthy 16-18% this fiscal — despite a high base of 20% growth last fiscal — on improved execution amid rising orders.

Revenue growth is expected to remain healthy, in double digits, at 10-12% next fiscal as well, supported by a strong order backlog and steady inflow of fresh orders. This takes forward two consecutive strong years for a sector that saw sluggish growth¹ in the decade through fiscal 2021.

Along with higher commodity prices, rising government and private sector spend on infrastructure and steady improvement in private capital expenditure in consumption-based sectors, including due to investment in productivity linked incentive (PLI) schemes, have resulted in strong order book growth.

The order book² expanded ~14% on-year in fiscal 2022 and by 9% in the first half of this fiscal to Rs 3.9 lakh crore. Consequently, the order book as of September 2022 was 3.82 times the revenue in fiscal 2022, up from the pre-pandemic (March 2019) level of 2.94 times.

A Crisil Ratings analysis of 74 companies with aggregate revenue of Rs 2.17 lakh crore, comprising ~46% revenue of the capital goods sector, indicates as much.

Says Anuj Sethi, Senior Director, Crisil Ratings, “Supportive public expenditure stemming from sustained government thrust on infrastructure and focused execution augur well for capital goods companies supplying to cement, energy, and steel product manufacturers. Further, capacity is being built for PLI-driven schemes in automobiles, pharmaceuticals, energy, electronics and textile segments, which is opening up opportunities for equipment sales this fiscal and the next.”

A pick-up in the private sector investment cycle coupled with continuing thrust from the government on infrastructure augurs well for future order inflows. At the other end, correction in the commodity prices from the March-April 2022 peaks, along with moderating economic outlook for export markets, may slacken the pace of order book growth in fiscal 2024, though it will still remain sizeable.

The growth in revenues also supported the profitability with operating margin rising by ~175 basis points (bps) on-year in fiscal 2022 to the pre-pandemic levels of ~9.5%. Increased execution of order book, coupled with softening of raw material (mainly steel, copper, aluminum) prices in the last 6-9 months, will result in better coverage of overheads and should drive further improvement in operating margins by 50-75bps to 10-10.25% this fiscal and the next.

Working capital intensity is expected to be steady for the sector. The ability to manage working capital levels is intact, as has been evident for many fiscals now, with average inventory and receivables steady around 85-90 and 110-115 days, respectively. This trend is expected to sustain through next fiscal.

Says Aditya Jhaver, Director, Crisil Ratings, “While working capital requirements will rise due to revenue scale-up, higher cash generation and moderate spend on capacity enhancements by capital goods players will keep their credit profiles ‘stable’. The debt to earnings before interest, tax, depreciation and amortisation ratio, and interest coverage are expected to improve to ~1.4 times and ~7 times, respectively, this fiscal, from 1.5 times and 6.3 times, respectively, last fiscal. These ratios are broadly expected at similar levels in fiscal 2024 as well.”

That said, the pace of pick-up in the investment cycle from the private sector, higher-than-expected slowdown in export demand, movement in the commodity prices and working capital management will bear watching.

¹ As indicated by revenue CAGR of 2.5% during fiscal 2011-2021 for the 74 companies analysed
² represent 15 listed companies which have reported order book; these companies contributed ~47% revenue share of the larger sample of 74 companies analysed