BSE Capital Goods index hits record high; here is what you need to know and top picks

BSE Capital goods index: The S&P BSE Capital Goods index hit an all-time high of 40,379.15 levels on Monday, June 19. Over the past 12 months, the index has jumped 63.5 per cent (including today's high). In comparison, the S&P BSE Sensex has rallied over 20 per cent during the same period. At close, the capital goods index stood at 39,820.24 levels, down 0.27 perc cent. 

Among individual stocks, Praj Industries (up 1 per cent) was the top gainer on the index, followed by SKF India and Siemens. Hindustan Aeronautics (HAL) and Bharat Heavy Electricals (BHEL) were also among the gainers.

Capital Goods Sector Q4 review

Pankaj Kumar, Research Analyst at Kotak Securities, notes that the fourth quarter (Q4FY23) of domestic revenues of capital goods companies showed decent YoY growth, despite moderation in the case of L&T. Order inflows have increased by a massive 69 per cent YoY and 17 per cent on a four-year CAGR basis, especially from companies such as ABB and Siemens, which would suggest a strong pickup in order inflows from the manufacturing sector.

"In addition, the larger outlay by the central government in FY24BE on capital expenditure is a positive for the infrastructure sector, although the slowdown in capital expenditure by states is a dampener. Most capital goods and infrastructure stocks are trading at higher multiples compared to their pre-COVID levels. We are positive about the long-term prospects of the sector, but the sharp increase in stock prices makes us nervous about any disappointments, leading to a correction in multiples," Kumar said in a note released on June 9.

Meanwhile, gross fixed capital formation (GFCF) touched a decadal high of 35.3 per cent of gross domestic product (GDP) in 4QFY23. While the government remains the key driver of this growth, capacity utilisation sustaining at nearly 74-75 per cent levels over the past year suggests that private capex may not be far behind, notes Teresa John, Deputy Head of Research and Economist at Nirmal Bang Securities. Further, capacity utilisation at nearly 80 per cent levels would be a key trigger for the private capex recovery. Nevertheless, over the past year, indicators such as capital goods production and capital goods imports have remained in positive territory. The operating profitability of BSE Capital Goods companies has also sustained positive territory, the report said further.

Gross fixed capital formation includes spending on land improvements (fences, ditches, drains, and so on), plant, machinery, and equipment purchases, and the construction of roads, railways, private residential dwellings, and commercial and industrial buildings. The disposal of fixed assets is removed from the total.

ICICI Securities notes that aggregate state governments’ capital expenditure (capex), which remained a laggard in FY23, is expected to pick up pace in FY24E to reach Rs 8.4 trillion based on state budget estimates and grow YoY at nearly 17 per cent on the base of FY23 BE. Assuming a slippage of 10 per cent, state capex could still reach the nearly Rs 7.6 trillion mark. The central government has already committed Rs 10 trillion (+36 per cent YoY on an actual basis) in the Union Budget towards capex which, given the robust tax buoyancy, appears achievable.

Household investments in real estate were the biggest driver of GFCF in FY22, accounting for 27.2 per cent of it. "We expect the real estate upcycle to continue being driven by strong demand pan-India, rising real estate prices, and the peak of the interest rate cycle behind us," analysts at ICICI Securities said in their report.

Given this, the brokerage is positive on stocks such as Larsen & Toubro, NTPC, BHEL, KEC International, JSPL, Jindal Stainless, Bharti Airtel, HPCL, IGL, Greenpanel Industries, Century Ply, BEL, Gujarat Fluoro, Archean Chemicals, and JK Cement in the industrial space.

Kotak Securities is positive on Cummins India (BUY, fair value Rs 1860) and Praj Industries (BUY, fair value Rs 450) in the space.

In its Q4 review note released on May 26, HDFC Securities said, in CY24, Cummins India expects to ramp up its manned capacity, which is currently at a utilisation level of 90 per cent as against its installed capacity utilisation of 60-65 per cent. Cummins India has multiple tailwinds, namely, stringent upcoming norms, capex cycle recovery, adoption of alternative fuels with lesser carbon footprint, revival in industrials and supporting manufacturing policies. 

"We maintain BUY, with an unchanged SOTP of Rs 1,880 (35x Mar-25 EPS)," the brokerage added.

As regards L&T, analysts at Prabhudas Lilladher, in the company's Q4 review note, said they believe L&T is well-placed to benefit in the long run with strong tender prospects, better order conversion in the domestic market, significant traction in the hydrocarbon segment from exports market and expected uptick in private capex. 

"The stock is currently trading at PE of 26.7/22.7 FY24/25E. Maintain BUY rating, with revised SoTP of Rs 2,615 (Rs 2,479 earlier), valuing core business at PE of 21x FY25E, (20x earlier), given sustainable growth visibility in revenue and order inflow front," they added.