Capital Goods: A High-Potential Sector To Bet On

Capital goods stocks, which had been trading at elevated valuations after rallies, experienced a sharp correction amidst foreign institutional investors’ ₹45,000 crore selloff in early October. However, the stocks swiftly rebounded as domestic investors capitalised on the lower prices, signalling sustained confidence in the sector. Mandar Wagh analyses the key factors driving optimism in the sector, reviews the financial performance of industry leaders, and examines the potential headwinds and tailwinds shaping the sector’s future trajectory 

The capital goods sector has been a favourite of investors because of its strong growth potential, critical role in infrastructure development and the rising demand driven by government initiatives and industrial expansion. According to published data, the Index of Industrial Production (IIP) registered significant growth in July, primarily fuelled by a surge in manufacturing activity. As of August 31, 2024, data from Finalyca PMS Bazaar revealed that portfolio management services (PMS) fund managers have placed significant bets on the capital goods sector, allocating 12 per cent of their AUM to it. 

This marks the second-highest allocation after the financial services sector, underscoring the potential for higher returns in capital goods, as reflected in the BSE Capital Goods index, which has soared over 50 per cent in the past year. Over the past few months, the sector has exhibited remarkable resilience, with the sectoral index maintaining steady performance and a positive tilt despite disruptions caused by intense heat waves followed by heavy rains, and weaker quarter-on-quarter growth compared to the March quarter. Let’s explore the key factors driving optimism in the sector, assess its sustainability and analyse the financial performance of industry leaders. 

India’s Capital Goods: Engine of Growth
The Indian capital goods sector plays a crucial role in the country’s economic framework, contributing around 12 per cent to the manufacturing sector and approximately 1.8 per cent to the overall GDP. Beyond its GDP contribution, the sector is vital for infrastructure and industrial development, serving as a key enabler for industries such as power, construction, mining, oil and gas, transportation and manufacturing by providing essential machinery and equipment. Additionally, the capital goods sector is a significant employer. 

It generates over 8 million direct and indirect jobs, thus supporting skill development and employment opportunities across various levels. India’s competitive manufacturing capabilities and cost advantages position it as a key player in the global supply chain for capital goods, particularly as companies worldwide diversify their production bases. The sector’s growth prospects have been bolstered by government initiatives such as the emphasis on industrial self-reliance. The government has announced an 11.1 per cent rise in capital expenditure, totalling ₹11.11 lakh crore. 

Increased investments in infrastructure, power and transportation are driving demand for capital goods, positioning the sector to benefit from the government’s infrastructure push. Furthermore, the capital goods industry is of strategic importance to India’s defence, space and energy security, providing critical equipment and technologies. In short, the capital goods sector plays a very crucial role in the socio-economic development of the nation and contributes to an overall improvement in the living standards of its people. Let’s explore the key segments within the capital goods sector and the growth factors that have fuelled optimism and are anticipated to drive further growth. 

Railway - The railway segment has experienced remarkable growth, largely fuelled by heightened government attention and infrastructure investment. Significant funding has been allocated to upgrade railway infrastructure, including the development of high-speed trains and dedicated freight corridors, which will enhance efficiency and reduce travel times. Notably, the Vande Bharat Express marks a major leap forward in India’s rail infrastructure, focusing on modernising train travel and improving passenger comfort. In addition, modernisation initiatives aimed at upgrading existing tracks, signalling systems and rolling stock are essential for boosting operational safety and performance. Growth is also being driven by an increasing emphasis on sustainability, with the implementation of greener technologies and electric trains. 

Shipbuilding - The shipbuilding segment is positioned for expansion, driven by the increasing demand for maritime trade globally. As international trade continues to grow, there is a pressing need for new vessels, which presents significant opportunities for shipbuilders. Government incentives and supportive policies are promoting shipbuilding and repair activities within the country, helping to boost local industry. Additionally, the focus on green shipping technologies to comply with international environmental regulations is becoming increasingly important. The development of eco-friendly vessels is not only meeting regulatory requirements but also enhancing the competitiveness of the Indian shipbuilding sector in the global market. 



Financial Performance of the Top 20 Capital Goods Companies by Market Capitalization

Defence - The defence sector has experienced a robust upward trend, driven by several key factors. The government’s ‘Atmanirbhar Bharat’ initiative aims to promote self-reliance in defence manufacturing, which has led to an increase in domestic production capabilities. This shift is supported by a rising defence budget, as the government allocates more resources to modernise equipment and technology. Strategic partnerships between domestic manufacturers and global defence firms are enhancing local capabilities and fostering innovation. Furthermore, there is a strong focus on indigenous production, with policies encouraging the development and manufacturing of home-grown defence systems, which is expected to bolster the sector’s growth. 

Electric Equipment - The electric equipment segment is set to grow significantly, fuelled by an increasing demand for renewable energy and energy-efficient technologies. The government’s emphasis on sustainable development and investments in renewable energy sources, such as solar and wind, is driving the need for advanced electrical equipment. Additionally, the rising awareness of energy conservation among consumers and industries is pushing for the adoption of energy-efficient devices. Moreover, the growth of electric vehicles (EVs) presents substantial opportunities for manufacturers of electric equipment, as the demand for charging infrastructure and related technologies continues to rise. 

Transmission Towers - The transmission tower segment is experiencing growth due to the rising demand for reliable power transmission and distribution infrastructure. With the increasing focus on expanding the power grid and integrating renewable energy sources, there is a need for robust transmission systems. Government initiatives aimed at enhancing electricity access in rural and remote areas further drive the demand for transmission towers. Additionally, the ongoing investments in smart grid technologies are creating opportunities for the development of advanced transmission solutions that enhance efficiency and reliability. 

Industrial Equipment - The industrial equipment segment is set for growth due to the resurgence of manufacturing activities in India. The government’s initiatives to boost the manufacturing sector and encourage investment are driving demand for a wide range of industrial equipment. The focus on automation and technological advancements in manufacturing processes is creating opportunities for manufacturers of industrial machinery and equipment. Furthermore, the increasing need for efficient and productive operations across industries is pushing companies to invest in modern industrial equipment, further supporting the segment’s growth. 

National Capital Goods Policy 2025
The National Capital Goods Policy 2025 is designed to accelerate growth in India’s capital goods sector, building on the foundation of the 2016 policy. The government is developing a comprehensive capital goods policy that will cover machinery used across multiple manufacturing sectors. As a result, representatives from at least 15 ministries are part of the task force. The government is also exploring strategies to boost the domestic manufacturing of machinery used in sectors such as defence, railways, steel, and others. 

Its primary goal is to boost domestic manufacturing, reduce dependency on imports, and increase the sector’s contribution to India’s GDP. By promoting advanced technologies, automation and innovation, the policy aims to make Indian capital goods globally competitive. Another key objective includes enhancing domestic production through research and development and fostering collaborations between industry, academia and research institutions to drive technological advancements. 

The focus is also on skill development to ensure a workforce equipped for modern manufacturing needs. Additionally, it promotes sustainability by encouraging energy-efficient and environmentally friendly practices. The policy also targets a substantial increase in exports through incentives and trade agreements, positioning India as a key global player in the capital goods market. Given the fact that a country’s industrial growth is directly linked to its economic prosperity, the government’s focus on promoting the capital goods sector is an apt one. This will surely propel the nation to being a global powerhouse. 

Key Financial Takeaways from Q1FY25
In evaluating the financial performance of the top 20 BSE-listed capital goods companies by market capitalisation, a clear trend has emerged. While year-on-year performance showcased robust double-digit growth in both revenue and profit, the quarter-on-quarter results reflected a significant decline. In Q1FY25, the Indian capital goods industry, represented by the top 20 companies, reported a notable 15 per cent year-on-year revenue growth. Leading the charge was Inox Wind Ltd., which recorded an impressive 83 per cent growth, benefiting from the government’s focus on renewable energy and rising demand driven by increasing public awareness. 

Jyoti CNC Automation Ltd. and Cochin Shipyard Ltd. also contributed significantly to this top-line growth, showcasing strong performance during the quarter. The aggregate net profit for the capital goods sector soared by 40 per cent year-on-year in Q1FY25, reflecting strong growth momentum and improved financial performance across key companies in the industry. Jyoti CNC Automation Ltd. emerged as a remarkable turnaround story in Q1FY25, rebounding from a loss of `14 crore in the same quarter last year to post a gain of `51 crore in the June quarter. 

Suzlon Energy Ltd., Inox Wind Ltd. and Mazagon Dock Shipbuilders Ltd. also posted impressive triple-digit year-onyear net profit growth. On the other hand, the sector recorded a 24 per cent quarter-on-quarter decline in aggregate revenue and a 43 per cent fall in aggregate net profit. The most significant decline was observed in Larsen and Toubro Ltd., a leader in the sector, along with Hindustan Aeronautics Ltd. and Bharat Electronics Ltd., two prominent defence public sector undertakings (PSUs). 

Several key factors contributed to the weaker results in the June quarter compared to March for capital goods companies. Seasonal influences play a role, as the March quarter benefits from year-end spending by companies and government agencies, while the June quarter often experiences slower activity. The onset of the monsoon season further slows infrastructure and project execution, impacting revenues. A temporary slowdown in new orders post-fiscal year-end also affects performance, while working capital pressures in this capital-intensive industry can hinder operational efficiency. 

What Stock Trends Reveal About the Capital Goods Sector
As previously mentioned, while benchmarks BSE Sensex and Nifty 50 gained 25-28 per cent over the past year, the sectoral indicator BSE Capital Goods index climbed over 50 per cent, significantly outperforming the main indices. This performance clearly indicates robust investor sentiment and heightened buying activity in capital goods companies. Consequently, numerous stocks, regardless of market capitalisation, have emerged as multibaggers, substantially boosting investors’ wealth. Inox Wind Ltd., in particular, was on a strong upward trajectory throughout the year. 

It delivered an impressive 300 per cent rally driven by solid financials and optimistic sentiment surrounding the renewable energy sector. Additionally, players in the defence segment also topped the charts. Considering the performance of the top 10 capital goods stocks by market capitalisation, these companies delivered an average return of 87 per cent over the past year. Notably, Suzlon Energy Ltd., Hindustan Aeronautics Ltd. and Bharat Heavy Electricals Ltd. more than doubled investors’ wealth within just one year! 

Risks and Opportunities
Considering the key risks, the likelihood of significant disruptions due to policy changes is minimal, especially with the current government retaining power, which reduces the potential for abrupt shifts stemming from differing political ideologies. However, geopolitical challenges persist, particularly amid tensions in the Middle East and concerns over rising global oil prices, alongside ongoing supply chain disruptions. Furthermore, as the Reserve Bank of India (RBI) has decided against cutting interest rates while the Federal Reserve moves towards rate cuts, fluctuations in interest rates are expected in the near future. 

In light of the prevailing risks, foreign institutional investors (FIIs) have pulled out a substantial sum of nearly `45,000 crore in the first week of October 2024. This significant withdrawal has been primarily driven by escalating geopolitical tensions in the Middle East and a shift in capital flows towards China following its stimulus measures. In the midst of the market turmoil, stocks in the capital goods sector, which had been trading at elevated valuations, have faced a sharp and sudden correction. However, it’s noteworthy that the sector exhibited resilience, with the sectoral index swiftly recovering to nearly its prior levels. 

This rebound was fuelled by domestic investors capitalising on the opportunity to acquire stocks at relatively lower prices, indicating a sustained confidence among investors. Let’s explore the reasons behind the confidence expressed by investors and market experts. The capital goods sector in India is set for significant growth in the third quarter, bolstered by a revival in infrastructure development. With the end of the monsoon season, the October-December period marks a notable postmonsoon construction surge. As weather conditions improve, construction activities are ramping up, particularly in road and railway projects, providing a crucial boost to economic activity. 

This rebound was fuelled by domestic investors capitalising on the opportunity to acquire stocks at relatively lower prices, indicating a sustained confidence among investors. Let’s explore the reasons behind the confidence expressed by investors and market experts. The capital goods sector in India is set for significant growth in the third quarter, bolstered by a revival in infrastructure development. With the end of the monsoon season, the October-December period marks a notable postmonsoon construction surge. As weather conditions improve, construction activities are ramping up, particularly in road and railway projects, providing a crucial boost to economic activity. 

Additionally, the impending fiscal year-end motivates both public and private sector entities to accelerate the completion of ongoing projects. Government policies also play a vital role, with increased fund disbursements for initiatives during the festive quarter. This financial backing fosters confidence among investors. The private sector, through public-private partnerships, is increasingly involved in infrastructure development, further propelling growth. Simultaneously, the power sector enhances the capital goods landscape, with rising industrial demand and festive consumption driving electricity needs. 

India’s focus on renewable energy projects aligns with this growth, as favourable post-monsoon conditions facilitate the construction of solar and wind initiatives. Therefore, investing in the capital goods sector for the medium-term to long-term could prove to be a sound investment decision. Investors should carefully assess the fundamentals and valuations, as these can vary significantly from company to company. The results from the September quarter will offer valuable insights into the future direction of these companies, aiding in informed investment choices.