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Subdued tractor outlook to weigh…

About the stock: Escorts is India’s fourth largest tractor maker (11.3% FY21 market share) and also serves the domestic construction equipment, railways space.

* FY21 sales mix – tractors 82%, construction equipment 11%, railways 7%

* Past five year CAGR: 44.9%, 59.8% in EBITDA, PAT; cash positive b/s

Q1FY22 Results: The company posted a relatively healthy Q1FY22 performance.

* Total operating income declined 24.4% QoQ to | 1,672 crore

* Margins dipped 164 bps sequentially to 14%

* Consequent PAT was lower by 34.3% QoQ to | 175 crore

What should investors do?

The share price of Escorts has grown >4x over last five years from ~| 270 levels in August 2016, vastly outperforming Nifty Auto Index.

* We retain HOLD rating given muted outlook for core tractor business

Target Price and Valuation: We value Escorts at revised SOTP-based TP of | 1,325 (15x P/E on core FY23E EPS, 30% discount on treasury shares; earlier TP | 1,140).

Key triggers for future price performance:

* Expect 11% tractor revenue CAGR over FY21-23E (7.5% volume CAGR), constrained by high installed base despite favourable macro tailwinds

* Construction equipment (CE), railways (RED) growth to be faster amid expected pick-up in economic activity and positive outlook for mining, construction, road building and general infra push by government

* Limited potential for incremental operating leverage gains in tractors along with lower contribution from tractors to keep margin prospects muted

* Optimum utilisation of surplus cash on b/s could be a large value driver

Alternate Stock Idea: In our auto OEM coverage we like M&M.

* Focused on prudent capital allocation, UV differentiation & EV proactiveness

* BUY with a target price of | 1,000

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