Global exuberance; domestic catching up

Edelweiss Research is also available on www.edelweissresearch.com, Bloomberg - EDEL, Thomson Reuters, and Factset Edelweiss Securities Limited

Global exuberance; domestic catching up

In this edition of Industrial Compass, we try to gauge global/local trends to assess our Nifty-beating model portfolio. Key observations: i) Exuberance in industrial stocks is globally-led, with domestic growth

lagging exports. ii) Reality check: Outperformance in industrial stocks is largely valuation-led, barring exporters and BEL (exhibit-9). Robust infra pipeline and simmering industrial capex (exhibit-10) should see material earnings catch-up ahead, unless covid plays a spoilsport.

Players with sharper EBITDA scale-up potential and structural levers should see incremental outperformance and account for a lion’s share of our benchmark-beating model industrial portfolio.

Global industrial names, domestic exports reflecting strong trends

A sharper sequential pickup in growth/OPMs is a common phenomenon for top

global industrial names and large domestic industrial exporters, implying a broad-

based global rebound and stronger pent-up demand. Notwithstanding concerns

w.r.t. chip shortage and supply-chain bottlenecks, commentaries and guidance are

upward looking led by more economies opening up and stabilising, painting a better

sequential pick-up picture (click to see global vs local growth/OPMs).

Back home: Industrial capex looking better; earnings catch-up key

While large industrials have clearly done better beating benchmark by 50–100%

(12M), this is largely driven by valuation re-rating as earnings catch-up lags. If one

takes a closer look at consensus, Cummins India, Bharat Forge and BEL are the only

players to see earnings upgrades during this period. In our view, domestic revenues

should see a better cyclical catch up going ahead led by robust infra outlook and

some pick up in industrial capex, reflecting in corporate commentaries as well as

encouraging capex upgrade in recent quarters for 40 of Edelweiss’s 200 coverage

companies (ex-IT/BFSI) (please click to see exhibit-10). Of course, any sharper

disruption from third wave could play spoilsport, delaying cyclical recovery.

Portfolio strategy: Go for potential EBITDA scale-up; structural levers

Our industrial model portfolio (click to see) has beaten Nifty by ~400bps (since Jan-

21, last major change) with high exposure to L&T and BEL, sharper cyclical benefits

from KKC, BHFC and automation beneficiaries such as ABB and SIEM. We continue

to avoid players with structural issues (ENGR, BHEL), and believe players offering: i)

EBITDA scalability; ii) TAM expansion; and iii) structural triggers could drive

significant wealth creation over two–three years.

Top picks: L&T, ABB, Honeywell, Cummins, BEL

Top avoids: BHEL, ENGR

India Equity Research Engineering and capital goods September 2, 2021

INDUSTRIAL COMPASS SECTOR UPDATE

Amit Mahawar Manoj Kumar K V Angad Saluja +91 (22) 4040 7451 [email protected] [email protected] [email protected]

INDUSTRIAL COMPASS

Edelweiss Securities Limited

2 Edelweiss Research is also available on www.edelweissresearch.com, Bloomberg - EDEL, Thomson Reuters, and Factset

Industrials recovery largely exports-led

Industrial exports leading growth cycle...

Source: Industry, , Edelweiss Research

…while domestic revenues have better scope

Source: Industry, Edelweiss Research

Revenue mix driving material margins, EBITDA % visibility better


-12%

-7%

-2%

3%

8%

13%

-60%

-20%

20%

60%

100%

140%

Q4

FY1

9

Q1

FY2

0

Q2

FY2

0

Q3

FY2

0

Q4

FY2

0

Q1

FY2

1

Q2

FY2

1

Q3

FY2

1

Q4

FY2

1

Q1

FY2

2

Exports revenue growth (ABB+BHFC+KKC)

Global IIP growth - RHS

-45%

-25%

-5%

15%

35%

55%

-35%

-20%

-5%

10%

25%

40%

Q4

FY1

9

Q1

FY2

0

Q2

FY2

0

Q3

FY2

0

Q4

FY2

0

Q1

FY2

1

Q2

FY2

1

Q3

FY2

1

Q4

FY2

1

Q1

FY2

2

Domestic revenue growth India IIP growth - RHS

64.9% 63.4% 62.4% 60.8% 59.0% 55.6%

14.1% 14.2% 13.2% 16.0% 17.6% 22.3%

13.4% 13.3% 12.4% 12.4% 13.6% 13.2%

7.7% 9.0% 12.0% 10.7% 9.7% 8.9%

0%

20%

40%

60%

80%

100%

FY17 FY18 FY19 FY20 FY21 Q1FY22

RM (% revenue) Emp cost (% revenue) Other Exp. (% revenue) EBITDA Margin


INDUSTRIAL COMPASS

Edelweiss Research is also available on www.edelweissresearch.com, Bloomberg - EDEL, Thomson Reuters, and Factset 3

Global Industrial margins steady with India to catch up sharply

Strong and steady growth of parents...

Source: Company, Edelweiss Research

…versus Indian entities


...reflecting better margin of parents…


Revenue ramp-up to drive India OPMs materially


-45%

-25%

-5%

15%

35%

55%

0%

4%

8%

12%

16%

20%

Q4

FY1

9

Q1

FY2

0

Q2

FY2

0

Q3

FY2

0

Q4

FY2

0

Q1

FY2

1

Q2

FY2

1

Q3

FY2

1

Q4

FY2

1

Q1

FY2

2

ABB Global margin ABB India margin

Global revenue (% YoY) India revenue (% YoY)

-70%

-30%

10%

50%

90%

130%

0%

4%

8%

12%

16%

Q4

FY1

9

Q1

FY2

0

Q2

FY2

0

Q3

FY2

0

Q4

FY2

0

Q1

FY2

1

Q2

FY2

1

Q3

FY2

1

Q4

FY2

1

Q1

FY2

2

KKC Global margin KKC India margin


-75%

-35%

5%

45%

85%

125%

0%

4%

7%

11%

14%

18%

Q4

FY1

9

Q1

FY2

0

Q2

FY2

0

Q3

FY2

0

Q4

FY2

0

Q1

FY2

1

Q2

FY2

1

Q3

FY2

1

Q4

FY2

1

Q1

FY2

2

Siemens Global margin Siemens India margin


-25%

-15%

-5%

5%

15%

25%

0%

5%

10%

15%

20%

25%

Q4

FY1

9

Q1

FY2

0

Q2

FY2

0

Q3

FY2

0

Q4

FY2

0

Q1

FY2

1

Q2

FY2

1

Q3

FY2

1

Q4

FY2

1

Q1

FY2

2HWA Global margin HWA India margin


INDUSTRIAL COMPASS



Strong commentary on US recovery and sustained momentum in China supports higher exports growth

Revenue growth Comments

ABB Total USA China

Jun'21 14% 14% 19% Demand in Oil & Gas to drive growth in America; China to sustain growth

momentum in short cycle businesses (Electrification and Motion to be

significant)

Mar'21 12% -5% 77%

Dec'20 0% -7% 17%

Siemens

Jun'21 21% 19% 14% Favourable macro environment to continue with some growth moderation in

China and a compensating acceleration in the US and Europe. Mar'21 9% 3% 44%

Dec'20 7% 5% 21%

Cummins

Jun'21 59% 75% 3% Improvement in truck production in North America; Demand for power

generation equipment (data centre etc.) in China to support growth with

softness in trucks and construction market.

Mar'21 22% 7% 83%

Dec'20 5% 1% 26%

Caterpillar

Jun'21 29% 30% 12% China to have another strong year with the industry in the above 10-tonne

excavator market about flat (on a strong base); NA to be supported by

residential and non-residential construction demand.

Mar'21 13% 1% 32%

Dec'20 -15% -22% -8%

Honeywell

Jun'21 NA NA NA Air transport flight hour’s recovery (leisure travel recovery to lag business

travel) is positive; Project & service orders up 25% YoY, YTD organic growth for

warehouse solutions at 69% YoY. USD4.7tn potential infra plan to boost

building & infra segment.

Mar'21 NA NA NA

Dec'20 NA NA NA


Industrial stock rally led by valuation re-rating; earnings to follow

Markets rewarding players with earning upgrades and earnings scale-up potential, disproportionately

Dec'20-Aug'21 Consensus Stock return EBITDA Margin revision (bps) Earnings revision PE growth

Company 12M Dec’20-Aug’21 FY22E FY23E FY22E FY23E FY22E FY23E

Companies with Margin/Earnings upgrade

L&T 74% 49% 50 60 -3% 5% 53% 42%

-L&T (ex-services)* 30 65 1% 7% 45% 36%

Cummins 116% 71% 260 240 21% 25% 43% 39%

ABB India 102% 69% 120 160 3% 11% 64% 52%

BEL 73% 62% 190 180 19% 14% 38% 40%

GRV 67% 59% - - -2% 1% 62% 57%

Thermax 80% 57% -20 20 1% 11% 55% 41%

Siemens 95% 49% 90 130 1% 6% 47% 41%

BHFC 55% 49% 300 230 35% 24% 11% 20%

Companies with Margin/Earnings downgrade

KPP 55% 30% -40 -20 -5% -2% 37% 32%

Honeywell 14% 24% 80 60 -20% -13% 55% 44%

KEC 26% 16% -180 -70 -13% 1% 28% 10%

EIL 3% -4% -240 -320 -12% -3% 9% -1%

BHEL 40% 60% -340 -150 -99% -32% 445% 76%

Source: Bloomberg, *Edelweiss Research


INDUSTRIAL COMPASS


Encouraging signs of pick-up in industrial capex benefit domestic

companies

40 of 200 (Edelweiss coverage) upgraded capex in last 6-8 months


Major capex upgrades announced by Edelweiss coverage (ex-BFSI, IT) universe in recent quarters

Company Type of Capex upgrade INR, bn

Metals

SAIL Brownfield expansion of 10-15mtpa at INR150bn, Mining infrastructure at INR34.5bn in next 2 years 163

JSW Steel Initial plus new brownfield expansion of 5mtpa at Vijaynagar and Enhanced infrastructure for mining 92

JSPL Brownfield capex of 5.5mtpa at Angul 60

Coal India 50% for land acquisition; 25% for equipment 43

Vedanta Aluminium smelting (414ktpa) and doubling the steel capacity 42

Oil & Gas

ONGC Capex, to be incurred on E&P and maintenance of existing blocks 35

IOCL Capex (including JVs) including (Refinery/ pipelines, Marketing and petchem) 22

HPCL Management has guided for capex of INR145bn in FY22 25

Power

JSW Energy Large scale renewables target of 20GW by 2030 40

NTPC Announcement of renewables and green hydrogen 100

Cements

Dalmia Bharat Announced new capacity addition of 10mtpa 50

Wonder Cement a new line 4 has been ordered 20

JK Cement Placed the order for the 1.5mtpa clinker and 2.5mtpa cement plant in Udaipur 14

Shree Cement 4mtpa plant in North India in media interview. 10

Deccan Cement Order placed for 1.5mtpa cement plant in AP 6

Consumer Durables KEI, Polycab and Philips of INR3bn each and Dixon (INR2bn) - all for capacity expansion 11

Industrials Polyplex (INR10bn), Carborandum (INR1bn), Orient Refractories (INR1bn) 10

Pharmaceuticals Divis Laboratories (Kakinada and Krishnapatnam projects) 10

Auto TVS (EV capex at INR6bn), SKF and Exide (Batteries of INR2.7bn) 9


Metals524 Power

140

Cement104

Oil & Gas92

Consumer durables11

Industrials10

Pharmaceuticals10 Auto

9 FMCG

5

INRbn

INDUSTRIAL COMPASS



Valuation snapshot


FY21 FY22E FY23E FY21 FY22E FY23E FY21 FY22E FY23E FY21 FY22E FY23E FY21 FY22E FY23E FY21 FY22E FY23E

Top picks

Larsen & Toubro Buy 1,686 1,975 1,360 1,579 1,872 156.2 187.4 237.2 11.5 11.9 12.7 49.1 71.2 88.9 34.3 23.7 19.0 10.0 12.5 14.0

ABB India Buy 1,894 1,975 58 73 83 2.8 6.2 7.9 4.7 8.5 9.5 8.1 21.6 28.1 234.0 87.6 67.5 4.8 12.1 14.2

Honeywell Buy 40,531 50,700 30 37 44 19.4 21.0 21.6 520.4 697.2 858.1 74.1 55.3 45.0 19.3 21.6 22.0

Cummins India Buy 1,040 1,115 43 55 63 5.8 8.0 9.5 13.4 14.7 15.2 22.3 28.4 32.6 46.7 36.7 32.0 14.4 17.3 18.6

Bharat Electronics Buy 190 205 141 164 187 31.8 36.2 41.1 22.6 22.0 22.0 8.5 10.2 11.5 22.4 18.7 16.5 20.0 21.6 21.7

Others

Bharat Forge Buy 781 1,000 63 89 106 8.6 18.0 22.8 13.6 20.1 21.4 3.9 20.3 28.2 202.3 38.5 27.7 3.4 16.5 20.3

Siemens Buy 2,285 2,360 131 164 175 9.9 14.3 19.3 7.6 8.7 11.0 31.3 41.7 44.8 73.0 54.8 51.0 11.3 13.7 13.3

KEC International Hold 423 445 131 147 167 11.4 12.0 15.1 8.7 8.2 9.0 21.5 23.0 29.8 19.7 18.3 14.2 18.0 16.4 18.3

Kalpataru Hold 414 440 77 88 101 8.1 9.4 10.7 10.5 10.6 10.6 29.8 38.0 43.7 13.9 10.9 9.5 16.6 13.9 14.2

Engineers India Reduce 72 65 31 33 34 3.4 4.4 4.7 10.9 13.5 13.8 7.4 8.8 9.6 9.8 8.1 7.5 20.5 27.7 26.9

BHEL Reduce 55 35 173 233 256 (31.4) 9.2 15.5 (18.1) 4.0 6.1 (7.8) 1.2 2.3 (7.0) 44.4 23.9 (9.8) 1.6 3.0

Thermax Reduce 1,402 970 48 60 69 3.6 5.5 6.4 7.4 9.1 9.2 23.0 34.5 40.2 60.9 40.7 34.8 8.3 11.4 12.1

Greaves Cotton Reduce 142 104 13 18 20 1.0 2.3 2.7 7.3 13.2 13.7 1.9 6.1 7.1 73.1 23.3 20.0 5.0 15.5 17.6

EBITDA margins (%) EPS (INR) P/E (x) RoE (x)Company Reco/

Rating

CMP

(INR)

TP (INR) Revenue (INR bn) EBITDA (INR bn)


INDUSTRIAL COMPASS


Edelweiss Portfolio snapshot

Top picks: Our pecking order & key value drivers/triggers:

L&T: a) Better-than-expected execution ramp-up. b) Better delivery on capital

allocation strategy and IT services consolidation.

ABB: a) Order intake momentum, rising share of new products/segments. b)

OPM scalability, which is lagging.

Honeywell: a) Higher export mandate by the parent, b) Better than expected

scale-up in new avenues (warehouse automation, city gas, datacentres, e-

commerce, etc).

Cummins India: a) Exports momentum sustainability especially. for large

products, b) Large KVA pick-up including Industrial BU. c) New mandates by

parent.

BEL: a) Execution ramp-up beyond guidance translating to better bottom line. b)

Bunching up of large system awards driving intake beyond INR130–150bn run

rate.

Snapshot of Edelweiss model portfolio

Company Mkt cap

(USD mn)

Mkt cap by

weights

(%)

New Weights

(%) Old Weights (%) CMP (INR) TP (INR) % upside Reco

Larsen & Toubro 32,429 41.8 55.0 50.0 1,686 1,975 17.1 Buy

ABB India 5,497 7.1 15.0 15.0 1,894 1,975 4.3 Buy

Honeywell Automation 4,906 6.3 10.0 12.5 40,531 50,700 25.1 Buy

Cummins India 3,949 5.1 10.0 5.0 1,040 1,115 7.2 Buy

Bharat Electronics 6,345 8.2 5.0 5.0 190 205 7.8 Buy

Siemens 11,145 14.4 5.0 10.0 2,285 2,360 3.3 Buy

Bharat Forge 4,982 6.4 - 2.5 781 1,000 28.0 Buy

KEC International 1,488 1.9 - - 423 445 5.3 Hold

Kalpataru Power (SA) 845 1.1 - - 414 440 6.2 Hold

BHEL 2,608 3.4 - - 55 35 -36.0 Reduce

Thermax 2,287 2.9 - - 1,402 970 -30.8 Reduce

Engineers India 623 0.8 - - 72 65 -9.7 Reduce

Greaves Cotton 449 0.6 - - 142 104 -26.6 Reduce

Sector 77,553 100 100 100


INDUSTRIAL COMPASS



Edelweiss portfolio outperforms Nifty by 400bps

Source: Bloomberg, Edelweiss Research

Edelweiss model portfolio vs benchmark

Period Performance (%) Performance vs benchmark (bps)

Edel Portfolio Nifty Nifty

1M 6.1% 8.6% -241

3M 13.0% 11.2% 177

6M 14.3% 17.6% -329

Since Inception (28th Jan’20) 28.4% 24.5% 388

Source: Bloomberg, Edelweiss Research

115

123

131

139

147

155

Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21 Jul-21 Aug-21

Edel Portfolio Nifty

All price charts cannot be included given the large of number of companies in our coverage. Specific charts may be available upon request


INDUSTRIAL COMPASS


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INDUSTRIAL COMPASS



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Aditya Narain

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