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* We initiate coverage on ACE with a Buy rating and a TP of Rs300, as we estimate FY21- FY24E EPS CAGR of 28%, driven by continued leadership in cranes, along with growing market share in the construction, material handling, and farm equipment arenas.

* With the GOI’s strong focus on Roads, Metro, High-Speed Rail, Water, Renewable Power and Airports, investments in the infra space are expected to pick up further. In addition, the government’s higher thrust on local manufacturing and PLI schemes for various sectors, along with ‘China plus one’ tailwinds, have made the prospects of the Indian manufacturing sector attractive. We believe this will be a major driver for the construction equipment sector. ICEMA estimates that the CE sector will see ~10% CAGR in FY20-30.

* In the medium term, defense and exports together have the potential to contribute ~15% to ACE’s topline. It could also help balance against the inherent cyclicality in domestic infrastructure spending. Moreover, exports are margin-accretive.

* We believe that the current uptick in infrastructure and industrial capex in India has further legs to it. Hence, construction equipment demand should grow further. ACE’s average RoE (last 5 years) was ~13.5%. For FY22-24, we estimate a RoE of ~16% and hence assign 10% premium to average PE of 18x (last 5 years). Our March’23 TP of Rs300 is based on a 20x one-year forward PE.

* Construction equipment industry’s medium-term growth outlook is strong: The government’s ‘Gati Shakti Plan’ envisages investments in sectors such as roads, railways, urban infrastructure, airports and ports. The PLI schemes announced for various sectors, as well as capex in steel, cement and power sectors, should drive equipment demand from industries. ICEMA estimates that the CE industry will see 9.5-11.5% CAGR in FY20-FY30.

* Leadership in cranes to continue; Backhoe loaders offer a large opportunity: ACE enjoys a leadership position in the cranes segment, with ~60% market share in Pick and Carry and Tower cranes, which form a large part of the overall crane market. The company is also trying to increase higher-tonnage market penetration. ACE’s established brand, R&D, in-house manufacturing and strong sales network are key factors contributing to its leadership. It has adopted a new strategy through an efficient product line of backhoe loaders and has obtained approval from most financiers. Backhoe loaders offer a large addressable market worth ~Rs90bn. ACE’s existing dealer network, pricing, and leadership in cranes should help it gain share in the backhoe loader space as well.

* Defense and exports hedge against cyclicality in the sector: Export revenue is expected to account for ~10-11% of total revenue in the medium term vs. 5-6% in FY19- FY21. This should be driven by global expansion efforts and new region-specific product launches on timely basis. Similarly, for defense needs, ACE is working on customized cranes, forklifts, skid-steer loaders, multipurpose tractors, tele-handlers, and special mobile equipment. It recently became an L1 vendor for supplying 482 multi-purpose tractors. It has also developed an indigenous Special Low-silhouette Knuckle Book Crane for DRDO. ACE has received a LoI from Tata Advanced Systems for the manufacturing and supply of these cranes for integrating them with TATA HMV 8*8 chassis. In the medium term, together defense and exports should contribute ~18-20% to the topline. This should also provide protection from the cyclicality in the CE space to some extent.

* Valuation and capital raise: We believe the infrastructure and industrial capex cycle has just begun. Hence, the medium-term outlook remains bullish for the CE sector. Our FY23 TP of Rs300 is based on 20x one year forward PE (10% premium to last 5 year avg.) as we estimate ~16% RoE during FY22-FY24E vs. ~13.5% RoE during last 5 years. ACE has raised Rs1.35bn through QIP for long-term growth (organic or inorganic), strategic acquisitions, financing capital requirements, working capital, and repayment of loans.

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