The capital goods sector has seen a valuation re-rating in the recent past. An analysis by Motilal Oswal Financial Services Ltd showed that currently, the sector’s stocks are trading at a price-to-earnings multiple of around 30.1 times, which is nearly 8% premium to its 10-year average. According to the domestic brokerage house, post the unlocking of the economy after the second covid wave, valuations have run up owing to strong government spending, healthy order inflows, and improving execution.
But for these valuations to sustain, many factors including their financial earnings performance, have to fall in place. Key monitorables for the sector comprise order inflows across companies, rising execution levels in crucial projects, improving liquidity situation, and spending by the central government, said the Motilal Oswal report published earlier this month. Failing which, the valuation premium may not for a long time.
The broking house highlights that the sector has seen multiple business cycles, and valuation multiples have followed. Over FY10-14, the valuation premium came off for the sector (30% premium to the Nifty) due to policy paralysis. After the FY14 general elections, the valuation premium expanded in anticipation of a capex cycle recovery over FY14-16, the valuation premium for companies in the sector increased significantly to 111% and 30% premium to Nifty and Sensex PE over FY11-14, respectively, in anticipation of a resurrection in capex activity, which failed to materialize, it said.
“Post FY16, the average premium to the Nifty P/E has narrowed to 49.4%, given (a) the lower-than-anticipated uptick in capex activity momentum and (b) the fear of ordering activity further slowing due to the CY19 general elections. As of October 2021, the sector premium relative to the Nifty stood at around 39%, below the long-term average of 42%,” added the report.
The September quarter earnings for the sector have shown recovery in order inflows and execution, though analysts say a full-fledged revival in earnings could take a few more quarters.
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