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1/ There has been a lot of interest of late in the #CapitalGoods space. Some observations in this thread
2/ Contrary to popular opinion that cap goods is a cyclical space there is a small subset of companies in this space which have delivered decent returns over decade plus time periods. Literally 5-10 odd cos
3/ Common thread: one or more of (a) great replacement demand revenue streams or make critical consumables in larger machines/engines (b) control their tech (c) have diversified end use cases (d) diversified geo ops to negate cyclicality and needless to say (e) strong mgmt teams
4/ Their revenue growth and return ratios are nearly half of what they were in the previous cycle 2004-07 (the companies which had reasonable scale then). Return ratios will follow revenue growth as operating leverage kicks in
5/ Revenue growth is preceded by gross block addition — a key metric to track across the space, across the world, esp of market leaders, which signify that they are seeing order visibility.
6/ But valuations across the space have run up. Earnings valuations are near if not above previous cycle (2004-07) highs. Ditto for FCF yields and balance sheet valuations
7/ The companies of the type described in /3/ will continue to compound capital but for animal spirits in the broader cap gods space you need the capex cycle to kick off
8/ And that is where there is a fundamental disconnect with valuations since IMO the credit cycle still has some time to fire, as corporate banks and psu banks, leading lenders to the space, are still / just coming out of the ICU.
9/ It is unlikely they will start lending to heavy industries/projects right away, the same ones which got them in the mess. Many of them have poor underwriting skills (majority don’t know infra is cyclical), rely on consortia leaders reports, saw this at close quarters in 2007
10/ The only other person who can fund large scale infra capex is the govt, though I am not sure they have the fisc space to do it. Divestment proceeds are an option but may take some time
11/ I think that the capex cycle is some time away. Till the credit problem is resolved, expecting animal spirits in the broader cap goods space is like putting the cart before the horse /fin
