Kotak rates Siemens as ‘Sell’, cuts EPS estimates by 2-3%

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Published: December 12, 2016 6:45:41 AM

Siemens does not envisage interest rate cut to revive private sector capex, given suboptimal utilisation levels, and envisions another 2-3 years for a full recovery.

Siemens does not envisage interest rate cut to revive private sector capex, given suboptimal utilisation levels, and envisions another 2-3 years for a full recovery. It is banking on recovery in government capex (T&D, metro, railways, smart cities, coal power capacities), deepening its presence in industrial spending (through digitalisation), and good quantum and quality of backlog. All these positives and much more are factored in the CMP; trades at 42X September 2018E core EPS (ex-other income). Sell; TP: R900

Mixed business outlook with government spending leading the way

Siemens shared green shoots in select sectors driven by government capex. These include power T&D (orders for HVDC network, STATCOM, rural electrification, exports), mobility ($8.5 billion of product ordering over next four years, 5-6 metro orders to be finalised in FY2017), smart city infrastructure (small orders happening for sure, select states turning supportive) and over the next 1-2 years, it also expects material demand for coal capacity addition given plans of states to retire large 36 GW inefficient capacity over the next six years and additional capacities for 7% demand growth. It, however, expects a full recovery in private-sector capex to take another 2-3 years, given the current 72-74% capacity utilisation levels (78-79% three years ago). Within private capex, Siemens noted scattered pickup (automobile, earth movers, roads equipment), moderation in cement and steel activities, and weak O&G prospects. Deepening presence in industrial spending through digitalisation

Through its 25-30 pilot projects in India, Siemens is installing sensors and actuators for a two-way communication between equipment subsystems. The aim is to allow the customer to use a cloud-based analytics platform, which has data aggregated across one’s equipment/factories. While leveraging its presence in the discrete automation products business, it is also taking such initiative beyond its customer base.

FY16: A modest year

FY2016 numbers paint a restraint picture with segmental margins down y-o-y in several key segments and/or remaining subdued. Strong 25% y-o-y ordering in FY2016 (over a y-o-y flat FY2015 base) led to a respectable order backlog of R126 billion (40% private sector share). With focus on quality orders in FY2016, Siemens does not envisage any hiccups in execution in FY2017. We marginally reduce our estimates by 2-3% to R23.6 and R29.3 for FY2017-18E. We assign 15X multiple to the cash EPS (high cash balance post healthcare sale) and 33X to the core business EPS, which yields a September 2018E target price of R900. The stock trades at a P/E of 42X September 2018E core EPS (ex-other income); downside risks to the estimates remain significantly higher than upside. Sell.

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Segmental outlook

The management shared detailed outlook for various segments. We have previously noted that the company is well-placed to capture the recovery on alignment of its business interests with the government’s vision and higher localisation-led improvement in competitive positioning. The segment-wise outlook is detailed below:

Power & Gas: The management believes that in order to fulfill the energy demand from increasing industrialisation and ‘Make-in-India’, the government will eventually increase power generation capex.

This segment also witnessed 18% y-o-y growth in order inflows in FY2016 but it was led by industrial steam turbines (<20 MW capacity) in mainly sugar and fertiliser industries. The company caters to utility scale supercritical ordering through a mix of own manufacturing and its licensing agreement with BHEL.

Energy management: This segment has been the key growth driver in FY2016 with ordering led by T&D equipment (HVDC, STATCOM, etc.). The management mentioned that with increasing installations of renewables, the grid stability deteriorates which would need grid stabilisation equipment. Further, GIS ordering is expected for smart cities and AIS for long-distance transmission.

Mobility: The company is witnessing a strong pipeline in railways for electrification, signaling and propulsion equipment. The company also expects tendering or at least enquiries for another 5-6 large metro rail projects in FY2017. The management also cited increasing ordering of train sets. We understand that Siemens is competing for the Kanchrapara rail factory for manufacturing EMU/MEMU coaches. The management mentioned that large volume ordering is needed in this space to offer competitive pricing.

Digital Factory: The company considers digitalisation as the key growth area for the next few years. The company has taken initiatives such as MindSphere platform for driving digitalisation-led solutions.

Process Industries and Drives: This segment has greater exposure to private capex compared to other segments. The company mentioned that private sector capex may take another 2-3 years to pick up significantly (while some green shoots are visible even today). In the meantime, this segment’s business is being driven by gears, motors and drives for renewable energy projects (such as wind power).

—Kotak Institutional Equities

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