Engineering
Resurrection
The engineering sector, a key beneficiary of the Rs28tn capex committed by Indian
corporates, has underperformed the Sensex by 25% in the past three months on
concerns of slowdown in capex spend and raw material cost pressure. However, we
believe concerns are exaggerated as projects under implementation have grown by
27% yoy to Rs28tn in 4QFY08, and reflected in strong order booking in the quarter.
Also, margins are likely to remain stable as companies increasingly opt for variableprice
contracts and long-term supply contracts with vendors. For our coverage
universe, we expect the robust order backlogs and stable margins to drive a 31%
CAGR in earnings over FY08-10. The current valuations (trading at 2-year lows) of
these stocks adequately factor in the concerns and offer an excellent opportunity to
increase exposure to the sector. We remain Overweight on the sector with Thermax
and Elecon Engineering as our top picks.
Concerns on capex slowdown exaggerated: Engineering stocks have corrected sharply
(30% in the past three months) dragged by concerns on slowdown in capex spend (slower
IIP growth). However, we believe the concerns are overdone as projects under
implementation are up 27%yoy in 4QFY08 to Rs28tn, led by capex underway in metals
(74%), power (30%), cement (71%) and construction (51%). Accordingly, we believe the
engineering companies under our coverage catering to these segments are likely to witness
consistent growth in order backlogs over the next 12 - 18 months (+37% in 4QFY08).
Strong earnings growth momentum: Considering the sharp rise in raw material prices,
there are concerns on margin pressures, which we believe companies are managing
through variable-price contracts and long-term supply contracts with vendors as also by
securing raw material supply within a short period of winning orders. Accordingly, we
believe margins are likely to remain stable. Consequently, we expect the strong order
flow and stable margins to drive a robust 31% CAGR in earnings of our coverage
universe over FY08-10.
Concerns priced in – Overweight: The engineering stocks index has underperformed
the Sensex (by 25%) over the last three months, which has led to a sharp correction in
valuations (48% on P/E basis). However, we believe the fundamentals of the sector
remain strong, while concerns are already priced in with P/Es at 2-year lows, we see this
as an opportune time to increase exposure to the sector. We remain Overweight on the
sector with Thermax and Elecon as our top picks.

CONTENTS
Investment Argument....................................................................................3
Demand growth to remain robust…..............................................................3
…Capacity catching up .................................................................................4
Stocks have reacted strongly to concerns........................................................7
Outlook on engineering sector remains robust.............................................12
Valuations and view.....................................................................................13
Companies ..................................................................................................16
AIA Engineering...............................................................................................17
Carborundum Universal ...................................................................................27
Elecon Engineering...........................................................................................37
Thermax...........................................................................................................49
Voltas ...............................................................................................................63