Challenging year ahead

Divergence between top-down and bottom-up views on the investment cycle is increasing. While the top-down view expects a cyclical revival led by macro recovery, potential reforms and interest rate easing, our bottom-up analysis suggests continued weakness in the investment cycle in FY14. Hence, we downgrade L&T to Equal Weight (Price Target R1,750) and downgrade Cummins to EW (PT R563). We recommend switching into interest rate sensitive stocks JPA and Adani Ports (both rated OW—Overweight).

Cycle view: While our overall view on cycle recovery is negative, in terms of relative end-market positioning, we are negative on the power (boiler/turbine) cycle, while we expect T&D (transmission and distribution) to weaken in FY14 and the industrial capex (capital expenditure) revival to remain elusive. Cement, steel, and downstream oil & gas should all be weak.

We are positive on the infrastructure order pipeline but the land acquisition/ approval process is constraining ordering and there is limited progress on easing bottlenecks. We expect road/dedicated freight corridor and metro orders to be strong. Within industrials, we expect fertiliser and upstream oil & gas capex also to be strong.

Key OW/UW picks: We prefer infra asset owners over capital equipment names. Our OW ideas in the infra sector are JPA and Adani Ports. Our key UW (Underweight) is BHEL. While we prefer L&T relative to BHEL, we downgrade it to EW to reflect the weak FY14 outlook. We also downgrade Cummins to EW due to steep valuations.

How are end-markets faring in FY13? In FY13 year to date, power boiler/turbine ordering has been weak while T&D ordering was strong. Infrastructure witnessed a mixed ordering trend across its various end-markets with roads being weak (only 1,000km ordered YTD in FY13), and airports and ports not seeing much ordering. However, metro and building orders have been strong. Industrial capex was weak with limited ordering in most end-markets so far. Sector valuations at the start of FY13 at 11.5x forward P/E (price-to-earnings ratio) were favourable but valuations have expanded by 40% to 16.5x forward P/E now.

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