Capital Goods and Defence - Q1FY22 Quarterly Preview

Earnings bounce from Q1FY21 lows Following a sharp demand recovery in Q4FY21, Q1FY22 was expected to begin on a positive note; however, growth was disrupted due to the second wave of the pandemic. Despite this, the downturn was relatively well- managed because companies had prior experience managing labor migration, supply chain disruption, and inventory management. Consequently, new projects fell 13.4% sequentially for the quarter, to Rs1.55trn, according to CMIE. Furthermore, the increase in commodity prices (which is now normalizing) has undoubtedly impacted margins; as a result, companies are focusing on automation and digitalization to increase efficiencies and mitigate the impact. Notably, there has been a structural shift in how businesses operate, with customers willing to pay a premium for greater energy efficiency/ better quality. Overall, recovery was witnessed in Renewables, Electronics, Metal, and Cement while investments in the Energy sector was deferred. Export markets are doing well as Covid-19 impact was waning across the geographies.

Within our Capital Goods universe, we expect Revenue/EBITDA/PAT growth of (excluding L&T) 48%/123%/152% YoY respectively owing to a favorable base and better adoption to 2nd wave of pandemic. EBITDA margin (ex-L&T) is likely to expand by ~395bps YoY, due to better operating leverage, favorable base, price hikes, and cost control & better efficiencies. L&T’s order inflow is expected at ~Rs300bn in Q1FY22, led by Power T&D, Heavy Civil Infra & Water sectors. It is likely to report Revenue/ EBITDA growth of 47%/114% YoY respectively.

In defence sector, we witness noteworthy DAC approval for a marquee submarine order worth ~Rs430bn which will most likely to be split between MDL and L&T, in our view. In addition, as part of a major push to develop an ecosystem in India, the government announced the second list of 108 items subject to import embargo. Furthermore, in the aftermath of the recent drone attack, we anticipate that drone technologies will gain traction, putting HAL and BHE at the forefront. Notably, BHE has guided a healthy growth rate of 15-17% for FY22E, while HAL is expecting an order inflow worth Rs400bn+ in FY22E. Among the defence coverage universe, we expect Revenue/EBITDA/PAT growth of 80%/ 175%/ 234% YoY in Q1FY22.

The Plant Load factor (April-May) stood at 71.1%, much higher than 53.7% Umesh Raut a year ago, for NTPC it was 72%. In a major move, the GoI approved a VP - Research package of more than Rs3trn for strengthening the distribution sector to +91 22 40969753 accommodate rising renewables and improve reliability. Moreover, a sector [email protected] is witnessing structural reforms with the draft Electricity Amendment Bill where some of the key things it talks of are a) removing cross subsidy among Tanay Rasal users, b) widening scope for private participation through distribution sub- Associate +91 22 40969753 licensees, and c) States to provide subsidy through DBT to discoms. [email protected]

July 06, 2021

DART View Given the pandemic's impact on Q1FY22, and the worst affected Q1FY21, it's difficult to envisage how growth will pan out. Nevertheless, we continue to prefer companies which can stand the test of time backed by strong diversified order book, execution capabilities, healthy balance sheet & better working capital management under capital goods coverage. Hence we prefer L&T, Cummins, Siemens, and ABB Power Products & Systems. In the Defence sector, we prefer companies with a strong order backlog, healthy execution visibility, and improved earnings traction. Hence, we prefer Hindustan Aeronautics, Bharat Electronics, Mazagon Dock, and GRSE.

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Major orders during Q1FY22 L&T Date Business segment Client name/Order type Classification Value (Rs mn) Power Transmission & EPC turnkey contract - Sudair Solar PV 09-Apr-21 Major 50,000-70,000 Distribution Project of 1.5GW capacity Business Nuclear - Order for 12 Steam Generators Significant 10,000-25,000 (SGs) from NPCIL 15-Apr-21 Heavy Engineering Refinery, Petrochemicals, Oil & Gas - Critical Reactor system package order for IOCL's Petrochemical Project Power Transmission & Orders to design and construct two Significant 10,000-25,000 Distribution 132/11kV Substations in Dubai Business Building & Order to construct a 3.5 MTPA brownfield 16-Apr-21 Factories Business cement plant in Nimbahera, Rajasthan EPC Package involves 25 KV Overhead Transportation Electrification, Power Supply, Signaling & Infrastructure Telecommunication and associated works Business in the Northeast Frontier Rail Contract from Oilfields Supply Company to design and build one of the World's largest Building & 22-Apr-21 Oil & Gas Supply Bases at King Salman Significant 10,000-25,000 Factories Business Energy Park, Dammam, Kingdom of Saudi Arab Chennai Metro - to construct nearly 12 km Twin Bored tunnels from Kellys station to Heavy Civil Taramani Road Junction station. And, to 14-May-21 Infrastructure construct approx. 8 Km of elevated Large 25,000-50,000 Business Viaduct with 9 elevated Metro Stations starting from Power House to Porur Junction including other associated works Bangalore Water Supply & Sewerage Water & Effluent Board - to Design, Build & Operate Sewage Treatment Significant 10,000-25,000 treatment Plants a Intermediate Sewage Business Pumping Stations Heavy Civil BARC - to construct various facilities within Infrastructure 07-Jun-21 42 months at Tarapur Business Construction of Sports Infrastructure facilities in the Kalinga Stadium at Building & Bhubaneswar, Odisha and a New Factories Business International Hockey Stadium with 20,000 seating capacity at Rourkela, Odisha Water & Effluent Repeat order from the Uttar Pradesh State Treatment Water & Sanitation Mission (SWSM) to 01-July-21 Significant 10,000-25,000 Business implement rural water supply projects under the Jal Jeevan Mission Building & Construction of residential towers in

Factories Business Mumbai's suburb of Mulund. Source: DART, Company

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KEC International Date Business segment Client name/Order type Value (Rs mn) Transmission & T&D projects in India, SAARC, Middle East, Africa, and the 6,290 Distribution (T&D) Americas. Railways Third Rail for Metro & Overhead Electrification (OHE) 4,460 21-Apr-21 Infra works in the Defence and industrial segments in 1,070 Civil India Cables Various types of cables in India and Overseas 630 Transmission & T&D projects in India, SAARC, Middle East, Africa, and the 3,260 Distribution (T&D) Americas. the construction of elevated viaduct along with stations 10,350 12-May-21 Civil for a metro project and for mechanical & civil works in two cement plants Cables Various types of cables in India and Overseas 1,530 Transmission & Transmission line and substation projects in India, Middle 4,180 Distribution (T&D) East, and the Americas 15-Jun-21 Railways OHE, Semi High-Speed Rail in India 2,940 Civil Infra works in the Metals & Mining segment In India 1,350 Cables Various types of cables in India and Overseas 900 Source: DART, Company

Kalpataru Power Date Business segment Value (Rs mn) 11-May-21 Consolidated 30,340 Source: DART, Company

Thermax Date Business segment Client name/Order type Value (Rs mn) Order for a claus package and an oxidiser package in the 25-June-21 Energy sulphur recovery unit for a greenfield refinery in Latin 2,500 America. Source: DART, Company

Engineers India Date Business segment Client name/Order type Value (Rs mn) 22-Jun-21 EPCM services NRL - Revamp of Delayed Coke Unit (DCU) 1,110 Source: DART, Company

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Capital Goods - Quarterly Preview (Rs mn) Sales EBIDTA EBITDA Margin (%) Adj. PAT EPS (Rs) Key Assumptions Companies Q1FY22E YoY (%) Q1FY22E YoY (%) Q1FY22E YoY (bps) Q1FY22E YoY (%) Q1FY22E . We anticipate a 20% YoY increase in revenues, supported by 15%/ 5% YoY increase in volumes/ realization. . Realizations are expected to improve as AIA 6,989 20.4 1,433 16.0 20.5 (78) 1,277 (1.2) 13.5 higher Ferrochrome prices would be passed Engineering on to customers. . Key things to watch would be clients addition & outlook on development activities. . Improving oil prices bode well for HWA because ordering from O&G will gain traction. . The sales growth is expected to be impacted Honeywell owing to a global shortage of 7,974 8.3 1,611 25.9 20.2 282 1,258 28.3 142.3 Automation semiconductors, which are primarily used in the production of field instruments such as transmitters, PLCs, and VFDs. . Margin is expected to expand YoY mainly due to reduction in travel cost. . Powergen/Industrials/Exports/Distribution revenue are expected to grow by 213%/175%/154%/64% YoY respectively. . Margin expansion YoY is expected due to Cummins 11,540 129.5 1,673 8,569.9 14.5 1,412 1,722 888.5 5.2 price hike, and improved sales mix. . The management's guidance on pricing actions, update on CPCB-4 norm implementation, and demand outlook would be key monitorable.

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(Rs mn) Sales EBIDTA EBITDA Margin (%) PAT EPS (Rs) Key Assumptions Companies Q1FY22E YoY (%) Q1FY22E YoY (%) Q1FY22E YoY (bps) Q1FY22E YoY (%) Q1FY22E . We expect RA/EL/MO/IA segment to grow by 91%/62%/47%/45% YoY respectively. We anticipate strong delivery momentum across the divisions, as well as an increase in services revenue. . Margin expansion on YoY basis would be led by better cost control measure, however, ABB India * 15,324 55.5 1,103 370.7 7.2 482 816 452.9 3.8 we expect slight pressure on margin on QoQ basis owing to shortage of semiconductors. . We are assuming normalized tax rate 25.2% vs higher tax rate of 31.1% in Q1FY21. . Key monitorable would be commentary on short cycle order and impact of semiconductor shortage on Robotics and Motion business. . We expect execution rate of 78% for CY21E with seasonality of 25% during the quarter. . Margin is expected to improve YoY basis largely due to operating leverage, however, ABB Power we expect slight pressure on margin QoQ 9,372 48.0 609 77.9 6.5 109 306 165.6 7.2 Products * mainly due to increase in IT expenses as the company is implementing new ERP system. . Management's outlook on timeline for upcoming HVDC projects & exports demand outlook would be key monitorable * Dec End

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(Rs mn) Sales EBIDTA EBITDA Margin (%) PAT EPS (Rs) Key Assumptions Companies Q1FY22E YoY (%) Q1FY22E YoY (%) Q1FY22E YoY (bps) Q1FY22E YoY (%) Q1FY22E . We expect Digital Industries/ Smart infrastructure/ Mobility/ Power & Gas to grow by 278%/ 167%/126%/92% YoY. . We anticipate revival of manufacturing capex driven by better demand for efficient enhancement in the industrials, while Siemens # 28,628 137.1 3,607 N/A 12.6 1,267 2,621 2,495.2 7.4 Mobility demand would be driven by capex in railway modernization, high speed rail & metro network expansion. . Moreover, a sustained recovery in short cycle orders is seen across core sector. . Key monitorable would be pick up in orders from Industrial/ Utilities segment . We expect revenue growth of 30%/15% in PMC/ LSTK segment. . Margin expansion mainly due to the Engineers execution of high margin order from PMC 5,793 23.8 695 224.2 12.0 742 813 68.9 1.4 India segment, and better operating leverage. . Key monitorable would be management's commentary on order pipeline & margin guidance. # Sept End

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(Rs mn) Sales EBIDTA EBITDA Margin (%) PAT EPS (Rs) Key Assumptions Companies Q1FY22E YoY (%) Q1FY22E YoY (%) Q1FY22E YoY (bps) Q1FY22E YoY (%) Q1FY22E . We expect revenue growth of 36%/42%/113% YoY in T&D (incl. SAE)/ Railways/Civil segment respectively. KEC International 27,379 24.1 2,327 19.4 8.5 (33) 968 36.7 3.8 . EBITDA margin contraction YoY due to unfavorable sales mix from civil segment. . Key monitorable would be order inflows from the Power T&D. . We anticipate execution rate of 61% for FY22E and build in seasonality of 21% for the Kalpataru Power 17,467 19.7 1,782 14.2 10.2 (49) 1,050 52.1 6.8 quarter, in line with historical run-rate. . Key monitorable would be reduction in promoter's pledge shareholding . We anticipate that core sales will increase by 68% YoY (largely driven Infra segment), albeit from a low base, while services revenue will increase by 10%. . We build in Core EBIT Margin at 7% & Non- core margin at 17%. We expect interest cost L&T 312,141 46.8 34,614 113.6 11.1 347 17,161 1,332.4 14.6 to reduce by 19% YoY due to strengthening of Balance sheet and improvement in WC position. . During the quarter, total order inflows could be worth Rs300bn+ led by Power T&D, Heavy Civil & Infra. . Key monitorable would be outlook for FY22E

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(Rs mn) Sales EBIDTA EBITDA Margin (%) PAT EPS (Rs) Key Assumptions Companies Q1FY22E YoY (%) Q1FY22E YoY (%) Q1FY22E YoY (bps) Q1FY22E YoY (%) Q1FY22E . We anticipate revenue growth of 173%/44%/28% YoY in the Environment/ Energy/ Chemical business as order execution gains traction, while momentum in the Chemical business is expected to Thermax 10,409 56.5 718 N/A 6.9 861 466 NA 3.9 continue. . Margin expansion due to better operating leverage, and favorable sales mix. . The key metric to keep an eye on is the outlook for new order inflows. . We are assuming 25% volume growth in EXIM and 60% in domestic freight, basing CONCOR 17,087 43.7 3,390 113.2 19.8 647 2,016 226.9 3.3 our assumptions on the rail container data of Apr-Jun, along with flat realisations. Sector Aggregate 470,102 47 53,562 119 11.4 30,473 379.7

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Defence - Quarterly Preview (Rs mn) Sales EBITDA EBITDA Margin (%) PAT EPS (Rs) Key Assumptions Companies Q1FY22E YoY (%) Q1FY22E YoY (%) Q1FY22E YoY (bps) Q1FY22E YoY (%) Q1FY22E . We anticipate execution rate of 30% for FY22E and build in seasonality of 16% for the quarter, in line with historical run-rate. . Margin expansion due to better absorption Bharat Electronics 25,362 51.8 5,199 254.4 20.5 1,172 3,451 537.6 1.4 of fixed cost. We have assumed normalized tax rate 25.2% vs higher tax rate of 29.0% in Q1FY21. . A key metric would be the translation of the Order pipeline into actual inflows. . Sales growth is expected to be driven by relatively higher execution from IAC project (final stage of execution) and recovery in ship repairing segment. . Expansion of margin mainly driven by Cochin Shipyard 7,138 114.7 1,392 716.7 19.5 1,437 1,155 170.9 8.8 contribution from IAC (relatively higher margin). . Key monitorable would be update on signing on NGMV order and recovery in ship repairing segment sales. . We anticipate execution rate of 8% for FY22E and build in seasonality of 16% for the quarter, in line with historical run-rate. GRSE 2,529 130.0 164 N/A 6.5 4,325 393 25,391 3.4 . Key monitorable would be impact of West Bengal lockdown on the Company’s operations.

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(Rs mn) Sales EBITDA EBITDA Margin (%) PAT EPS (Rs) Key Assumptions Companies Q1FY22E YoY (%) Q1FY22E YoY (%) Q1FY22E YoY (bps) Q1FY22E YoY (%) Q1FY22E . We anticipate execution rate of 10% for FY22E and build in seasonality of 20% for the quarter, in line with historical run-rate. . Expansion of margin due to better operating leverage. MDL 9,599 150.0 586 262.8 6.1 190 1,361 29.5 5.9 . Highly-awaited submarine order worth Rs430bn was approved by DAC during the quarter (likely beneficiaries MDL, L&T). . Key monitorable would be an execution timeline for its robust order book. . We anticipate execution rate of 28% for FY22E and build in seasonality of 13% for the quarter. . We expect lower interest expense due to deleveraging of BS and improvement in WC HAL 31,540 81.6 7,254 85.3 23.0 47 5,454 260.1 16.3 position. Furthermore, we expect higher treasury income led by higher stage payment received for LCA project. . Key monitorable would be sustenance of growth in ROH & spares segment in medium term. Sector Aggregate 76,168 79.9 14,595 174.9 19.2 - 11,815 234.2 -

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Utilities - Quarterly Preview (Rs mn) Sales EBITDA EBITDA Margin (%) PAT EPS (Rs) Key Assumptions Companies Q1FY22E YoY (%) Q1FY22E YoY (%) Q1FY22E YoY (bps) Q1FY22E YoY (%) Q1FY22E . We expect no major change to its FY22 NTPC 266,250 13.5 81,206 4.8 30.5 (252) 31,548 27.7 3.2 capex guidance. We have assumed generation of 75BU for the quarter. . PGCIL's capex and capitalization guidance will be keenly watched. We do not expect Powergrid 99,185 10.3 88,275 12.1 89.0 137 34,145 72.5 6.5 major change in FY22 guidance on either parameter Sector Aggregate 365,435 12.6 169,481 8.5 46.4 65,693 47.7

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DART RATING MATRIX Total Return Expectation (12 Months)

Buy > 20% Accumulate 10 to 20% Reduce 0 to 10% Sell < 0%

DART Team

Purvag Shah Managing Director [email protected] +9122 4096 9747

Amit Khurana, CFA Head of Equities [email protected] +9122 4096 9745 CONTACT DETAILS Equity Sales Designation E-mail Direct Lines Dinesh Bajaj VP - Equity Sales [email protected] +9122 4096 9709 Kapil Yadav VP - Equity Sales [email protected] +9122 4096 9735 Jubbin Shah VP - Equity Sales [email protected] +9122 4096 9779 Yomika Agarwal VP - Equity Sales [email protected] +9122 4096 9772 Anjana Jhaveri VP - FII Sales [email protected] +9122 4096 9758 Lekha Nahar AVP - Equity Sales [email protected] +9122 4096 9740 Equity Trading Designation E-mail P. Sridhar SVP and Head of Sales Trading [email protected] +9122 4096 9728 Chandrakant Ware VP - Sales Trading [email protected] +9122 4096 9707 Shirish Thakkar VP - Head Domestic Derivatives Sales Trading [email protected] +9122 4096 9702 Kartik Mehta Asia Head Derivatives [email protected] +9122 4096 9715 Dinesh Mehta Co- Head Asia Derivatives [email protected] +9122 4096 9765 Bhavin Mehta VP - Derivatives Strategist [email protected] +9122 4096 9705

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