Over the last year, the BSE Capital Commodities Index has generated a return of around 43%, not only beating other indexes, but also becoming the best performing of all industry indexes. Furthermore, since the Covid low (April 3, 2020), it has increased by about 246%, outperforming Sensex by more than 100%. Such a strong showing comes after a decade of underperformance.
Between 2010-2019, while Nifty and Sensex delivered an absolute return of around 135%, the Capital Goods Index only gained about 20% due to a downtrend in the capital investment cycle. But government infrastructure spending, strong capital order flows and expectations of a recovery in private investment have fueled the current capital goods segment.
Government push and macro
The performance of the capital sector is often linked to overall investment activity in the economy, expressed as the ratio of total fixed capital formation (GFCF) to GDP. As reported by Jefferies, fiscal year 22 and fiscal year 23E saw the GFCF account for about 29% of GDP, up from around 27% seen in fiscal year 21. Of course, one could argue that the same figure is not as high as the GFCF with about 36% of GDP in 2003-2008, the boom of the capital investment cycle. Between 2010-2019, the GFCF fell from 34% in 2011 to 28%, resulting in less than impressive performance.
During a recent webinar, Chirag Shah, Vice President, Research, ICICI Securities, said that in the 2003-2008 investment cycle, there were only 3-4 sectors – thermal power-based power generation, Petroleum and metals lead the way. While the previous cycle was a focused and ambitious investment cycle, the current cycle seems to be based on a broader range. The current investment cycle appears to be driven by sectors such as power transmission and distribution, railways, defence, green energy value chains, data centers, automation and factory digitization. .
In addition, in the current investment cycle, the Center has held a pivotal position in leading investment capital. The central government’s share of investment spending to GDP, at 2.9% in the 2022 Union Budget, has been increased to around 3.3% this year. These rates averaged 2.6% and 1.7% over the periods 2003-08 and 2011-19 respectively.
Strong order book
Thanks to a government push, subsidiaries of MNCs in India, ABB India and Siemens, have been among the best performers with 30% and 35% increases in their order flows. in CY22. They are driven by orders related to automation, railroads, power transmission and distribution (T&D) space, and data centers. Shares of ABB India and Siemens are up about 65% last year.
EPC companies such as L&T, KEC International and Kalpataru Power saw record high orders in the period 2022-23 with an increase of about 19-40%. These companies have an order turnover ratio for 2023 in the range of 1.76-3.2 times, showing their strong revenue visibility. Kalpataru and KEC see strong attraction from segments such as T&D electricity, railways, water and urban infrastructure.
Furthermore, the defense theme also seems to be gaining attention due to the localization process and higher government spending on defense. Supported by this, shares of aircraft maintenance and manufacturing company Hindustan Aeronautics (HAL), have risen 82% in the last year. HAL and Bharat Electronics have backlogs of orders about 3.5-4.5 times their revenue. Larsen & Toubro also received strong growth orders from the defensive space.
That said, the maintenance and growth of this capital cycle will depend on whether the private sector does. What could work in their favor is that a company’s balance sheet is stronger today than it was in previous cycles.