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Published on 13/12/2019 10:28:26 AM | Source: SPA Securities Ltd

Update On Escorts Ltd by SPA Securities

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Escorts Ltd. (EL) reported net sales of INR 13.2 bn in 2Q FY20 (~5.3% decline over INR 14 bn YoY) and a PAT of INR 1 bn (flat YoY). Escorts Farm Equipment (EFE) segment volume declined 8.6% while Escorts Construction Equipment (ECE) segment volume a declined 28.8%. EBITDAM (excluding other income) contracted by 169 bps YoY (43 bps QoQ) on the back of negative operating leverage despite cost reduction initiatives and price increases taken during the quarter. Production cut taken to adjust dealer inventory also hit margins. RM cost as % of sales decreased 56 bps while Operating & Manufacturing Expenses and employee expenses as % of sales increased 88 bps and 138 bps YoY respectively.

 

Flagging volumes in both EE and EFE divisions dragged revenue

Domestic tractor industry reported a volume decline of 10% for the quarter while EFE volume declined 8.6%. Export tractor volume for the industry declined 16.9% while Escorts outperformed registering a growth of 97.7%. Market share in the quarter stood at 11.2% (up 70bps YoY, up 10 bps QoQ). Inventory at the dealers currently stands at 4 weeks and the same at the company stands at less than 2 weeks which is a comfortable level to be with. Dealer inventory for the industry remained high. We don't see major production cuts going ahead. ECE volume declined 28.8% YoY (down 11.4% QoQ). Served ECE industry volume comprising Backhoe Loaders, PnC and Compactors declined by 30.1% in 1QFY20. Revenue from EFE/ECE segments stood at INR 9.96 bn/2 bn falling 4.6%/19.3%. Revenue from Railways stood at INR 1.27 bn (up 19.6% YoY) while order book for the segment stood at INR 5 bn executable over 13-15 months.

Negative operating leverage, adverse product mix, higher contribution of newer railway orders with lower margin and higher employee cost hit margins despite softening RM cost and cost reduction initiatives.

EBITDAM (excluding other income) declined by 169 bps YoY. EBIT margin in EFE reduced 330 bps YoY to 10.9% due to negative operating leverage (~160-170 bps) and production cut taken (~160- 170 bps) which was partly offset by softening RM cost (~20-30 bps). In absence of steep production cuts, margins will move in tandem with volume growth. ECE division reported EBITM of 2.7% (up 195 bps YoY), despite fall in volumes. Due to cost reduction measures and improving production mix, breakeven levels for the segment have come down to 208-300 units/month. Railway equipment division reported EBITM of 19.1% (down 91 bps QoQ) for the quarter but margins are expected to stabilize at 17-18% as incremental orders in the pipeline are of lower margin newer products with higher import content.

 

Other highlights

Competitive intensity remained stable in the industry with no major change in discount levels. 2Q retail sales were better than the wholesale numbers and the industry performance signalling moderation in volume de-growth for Escorts. With comfortable inventory, management expects to continue outperforming industry going ahead. Net Debt stood at -INR 391 Cr.

 

Outlook and Valuation

Performance in EFE division has shown signs of recovery in last couple of months while ECE volumes are expected to pick up in FY21. Improving margins in ECE division and increasing contribution of railway division is expected to partly offset margin pressure due to fall in volume in EFE segment. We expect Revenue/EBITDA/PAT to grow at a CAGR of 9.3%/5.7%/ 11.1%from FY19 to FY21. At CMP of INR 647, stock is trading at 11.6x its FY21E earnings (vs average of 18.4x for last 5 years). We believe that most of the negativity is factored in the price and maintain buy with a revised fair price estimate of INR 784 in 12- 18 months, 14x its FY21 EPS.

 

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