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Structure simplified, merged entity well placed to grow

About the stock: The company is a prominent tractor maker domestically (10.3% FY22 market share). It also serves domestic construction equipment, railways space.

* FY22 sales mix – tractors 77%, construction equipment 14%, railways 9%

* Past five year CAGR: 24.1%, 35.6% in EBITDA, PAT; cash positive b/s

Key Highlights:

* Escorts Kubota passed a resolution to amalgamate Escorts Kubota India Pvt Ltd (EKI, JV between Escorts & Kubota in 40:60 ratio, tractor manufacturing entity) & Kubota Agriculture Machinery Pvt Ltd (KAI, JV between Escorts & Kubota in 40:60 ratio, including all farm machinery presence of Kubota in India) into Escorts Kubota Ltd for swap ratio of 5:129 & 5:220, respectively

* In FY22, EKI & KAI had revenue of | 689 crore & | 1820 crore, respectively. EKI incurred a loss of | 96 crore while KAI generated profit of | 53 crore

* This comes in line with the earlier announcement made at the time of Kubota acquiring a further stake in the company and joining as co-promoter. It is aimed at simplifying the group structure with listed entity now including Kubota’s complete presence in India

* Our View: Swap ratio & consequent value assigned to the residual stake is fair in our opinion thereby protecting the interest of minority shareholders

* The stakes are being acquired at ~1.2x P/B with effective cost of acquisition pegged at ~| 276 crore (i.e. 13.8 lakh shares multiplied by CMP of 2,000)

What should investors do:The stock price has grown at ~26% CAGR over last five years from ~| 636 in September 2017, vastly outperforming the Nifty Auto Index.

* We upgrade the stock from HOLD to BUY tracking Kubota’s strength in farm machinery space with key monitorable being medium term growth plan

Target Price and Valuation: We await b/s of merged entity before incorporating the same in our financials. Keeping the standalone financials intact (erstwhile Escorts) & assuming to be merged entities operating unchanged, we value EscortsKubota on SOTP basis at | 2,390; valuing it at 25x PE on combined PAT in FY24

Key triggers for future price performance:

* Formal plan on scaling up operations of the company and leveraging channels using expertise of new co-promoter Kubota

* We expect sales to grow at CAGR of 11% over FY22-24E, with consequent margins expected at 12.5% by FY24E

* RoIC profile of ~30% (RoCE is suppressed due to high cash on b/s)

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