Construction equipment - Building on the boom

Demand for infrastructure and construction equipment is set to increase. The Eleventh Plan, entailing an investment of about $492 billion on infrastructure projects alone, is likely to be the main growth driver.

Srividhya Sivakumar

Companies in the engineering and construction sectors have never had it better. With increasing allocation of funds towards infrastructure development, the fortunes of these companies have changed dramatically. The spill-over effect from these investments has also pepped up the outlook for the equipment industry. Offering a proxy play on the infrastructure growth story of India, the equipment industry appears set to grow at a blistering pace.

While the stocks in this segment enjoy premium valuations, the burgeoning order books stand testimony to strong prospects. What are the demand accelerators for this industry? How are the companies planning to take advantage of the demand? What are the key factors that will determine their success? Here are a few takes on the underlying trends.

Growth drivers in place

Demand for infrastructure and construction equipment (ICE) is set to increase, given the growing thrust on infrastructure development. The Eleventh Five Year Plan, entailing an investment of about $492 billion on infrastructure projects alone, is likely to be the main growth driver (incremental investment of about $40 billion annually).

While this will directly benefit engineering and construction companies, it will also buoy the demand outlook for the equipment industry. In addition to this, the fact that equipment costs typically constitute about 4-24 per cent of the total project cost also brings to fore the growth that this industry could witness. Notably, the equipment industry has grown by about 25-30 per cent annually over the past couple of years.

The availability of easy credit options to purchase infrastructure and construction equipment is also a positive. While in the past larger companies (equipment users) enjoyed easier access to credit from the big banks and other financial institutions, their smaller counterparts were not as lucky in tapping capital, and often forced to postpone their purchases. This scenario has changed with the emergence of equipment financing companies with focus on small and medium-sized contractors. Such financing options will not only help these companies get easier access to financing solutions but will also help expedite their purchase decisions.

For instance, the presence of companies such as SREI Infrastructure and Finance, Birla Global Finance and Cholamandalam DBS Finance, which cater to small and medium-sized contractors, has widened the financing options for the user companies. Interestingly, SREI also provides assistance to its customers throughout the lifecycle of the equipment. However, given the strong demand scenario, financing options in the market leave sufficient scope for expansion.

Going forward, exports can emerge as a strong growth driver, given the current domestic market bias of these companies. In this context, evolution of R&D capabilities and an established low-cost manufacturing base are likely to act as enablers. However, given the blistering growth in domestic demand, it could well take a few years before these companies decide to increase focus on exports.

Equipment rentals – the next trend

The purchase decisions of ICE also depend on the criticality of their function to the user's business operation. In contrast to equipment acquisition, which burdens the purchaser's balance sheet, hiring or leasing options by equipment rental companies for not-so-critical equipment offers an easier option for the user. Predominantly unorganised, the rental businesses could witness more action given the flexibility they provide the users.

In the organised market, players such as Quipo Equipment Rental and Sanghvi Movers have established their presence. Sanghvi, which rents out cranes, has a fleet size of about 260 cranes and enjoys a 50 per cent market share in the segment. Quipo has set up equipment banks across the country and provides equipment on rent. Additionally, it takes deposits of idle equipment and provides returns thereon to owners on their idle assets. The business model of Quipo, promoted by SREI Infrastructure and Finance with Ingersoll Rand, Swedfund and L&T as key stakeholders, has gained popularity. Its association with Ingersoll and L&T has also benefited the company by way of discounts on equipment purchases, after-sales support services and joint market development for rental services. Gremach Infrastructure Equipments and Projects is another player that rents out construction and earth-moving equipment.

Funding capacity expansion

Most of the ICE companies, in order to meet the rising demand, have embarked on capacity expansion. While the expansion in capacity has predominantly been focused on existing offerings, a few companies have also sought to expand their product portfolios. The funding of these capex plans has seen a differing trend across companies.

While companies such as Action Construction Equipment and Gremach Infrastructure tapped the primary market via an initial public offering, Bharat Earth Movers raised funds through a follow-on public offer. Given the overwhelming response to the public offers of these companies, more such companies could tap the primary market. Material-handling company Tecpro Systems, for instance, is slated to go the IPO way soon. Some companies, however, went the private equity way. Escorts Construction Equipment raised about $17 million from US-based Darby Overseas Investments. Quipo was another company that chose the private equity route; it attracted funding of about $50 million from GIC of Singapore and IDFC. Sanghvi Movers has also used debt to fund its expansion. Notably, Indian subsidiaries of MNC players have attracted increased investments from their parent company.

Foreign companies – eyeing the Indian pie

Given the growth prospects of this industry, it is not surprising that MNCs have marked their presence in this segment.

While some have set up Indian subsidiaries, others have formed strategic alliances with domestic players. The UK-based JCB and Germany-based Schwing Stetter have established proprietary businesses in the country. Notably, the Indian subsidiaries of both these firms have raked in significant business over the recent years — JCB India, for example, has evolved to become the group's largest market, having recorded four times' increase in sales over the last five years. Alternately, companies such as Terex Vectra, a 50:50 joint venture between Terex Corporation of the US and Vectra Ltd of the UK, have also etched their presence. Joint ventures and strategic tie-ups between global and domestic players has also been a popular model. While global equipment leader Caterpillar has an alliance with GMMCO, Komatsu has tied up with L&T. Hitachi Construction holds a 40 per cent stake in Telco Construction Equipment Company. This space could see more action with more foreign companies announcing plans to enter the Indian market. For instance, Scania of Sweden has announced its India entry with a tie-up with L&T. Yanmar Construction Equipment Company of Japan has also announced its India foray.

Critical success factors

The entry of several players in this space, while good for market expansion, has also increased the competition for existing domestic players. Further, increasing imports from low-cost countries such as China could also add to the pressure. In the light of increase in competition, factors such as distribution network, technology tie-ups, pricing strategies and after-sales service can emerge as key differentiators. While multinational companies have an edge over domestic ones when it comes to technology, the latter score in terms of the reach of their distribution network. Raw material cost, going forward, could also emerge as a significant challenge. In this context, global players with presence across various countries could be at an advantage if the cost dynamics were to shift in favour of some other country.