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Likely Cyclical Down-turn & Competition to Drag Bottom-line; Maintain REDUCE
Escorts (ESC) has reported below par performance in 4QFY19 due to margin contraction and higher interest outgo. Its revenue, EBIDTA and adjusted PAT grew by 14% YoY (-1.4% QoQ), 9% YoY (-5% QoQ) and 8% YoY (-9% QoQ) to Rs16.3bn, Rs1.9bn and Rs1.2bn vs. our estimate of Rs16.6bn, Rs1.96bn and Rs1.3bn, respectively. Its EBIDTA margin fell by 47bps YoY/48bps QoQ to 11.6% (our estimate of 11.8%). While tractor volume grew by 7% YoY, construction equipment volume fell by 6% YoY. Notably, its railway segment’s revenue rose by a strong 36% YoY. Its RM/ sales increased by 88bps YoY (-75bps QoQ) to 68.8%, while other expenses/sales remained flat YoY and increased by 123bps QoQ to 12.3%. Its EBIT margin stood at 13.1% and 15.1% for Agri business and Railway business, respectively.
Following a spectacular performance over the last three years, the tractor industry is expected to take a breather in FY20E and would undergo a cyclical downturn in FY21E. Lower water reservoir level led by monsoon deficit would have a negative impact on agri output in FY20E and resultantly would impact the tractor volume across regions. Though non-agri usage of tractors would drive the volume to some extent, it would not be sufficient to compensate the expected fall in agridriven tractor demand. Moreover, as we also expect similar downturn for construction equipment segment, we reduce our volume growth estimate for FY20E and FY21E. Further, current higher inventory in industry would increase competitive pressure for all players, which would further compress operating margin, going forward. ESC’s capex plan would also impact cash flow over the next 2 years. In view of expected cyclical down-turn, higher inventory, cash flow squeeze due to high capex impacting return ratio, we lower our target P/E valuation multiple for ESC from 13x to 11.5x 1-Year forward. Moreover, poor visibility on tractor industry’s volume performance over next 2-3 quarters strengthens the case for valuation downgrade. Therefore, we maintain our REDUCE rating on Escorts with a revised Target Price of Rs600 (from Rs760 earlier).
Market Share to Rise; Margin to Remain under Pressure
We believe that ESC would continue to gain market share in 1HFY20E supported by its product strength, marketing strategy and favourable geographic-mix. However, post-2019 monsoon, we expect the other Western and Southern geographies (weaker markets of ESC) would bounce back strongly and resulting into challenge for its market share expansion, while M&M would regain lost market shares. We believe that competitive intensity would increase due to higher inventory, which would further increase the pricing pressure. We believe that higher RM cost and wage inflation coupled with limited pricing power would lead to ~80bps contraction in ESC’s margin to 11% over FY19-FY21E.
Outlook & Valuation
We expect ESC’s tractor volume to grow by 5% YoY in FY20E and fall by 7% YoY in FY21E. We reduce our construction equipment volume estimate by 8%/17% for FY20E and FY21E, respectively. We lower our revenue and EBIDTA estimates by 0.4%/2.4% and 5%/6% for FY20E/FY21E, respectively. Accordingly, we cut our EPS estimates by 10%/11% for FY20E/FY21E. In view of likely down-turn for tractor industry, slowdown in construction equipment segment along with poor visibility on tractor volume performance, we reiterate our REDUCE recommendation on ESC with a revised Target Price of Rs600 (from Rs760 earlier), valuing it at 11.5x FY21E EPS.
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