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Weak Q2 on cost pressures; mediumterm prospects remain robust

Q2FY23 EBITDA declined by 33% YoY to Rs1.53bn, coming in 22% below our estimates due to increase in vehicle discounts and cost pressures. Management expects margins to normalize over the next few quarters, owing to reduction in discounts, commodity deflation, price increases and cost savings. Revenue grew by 12% YoY to Rs18.8bn, in line with our estimates. Factoring-in the lower-margin assumptions, we reduce FY23-25E EPS by 6-9%. Escorts remains one of our top sector-picks, underpinned by expectations of a Tractor-industry upcycle and robust medium-term prospects. Led by support of new Joint Promoter Kubota, we expect Escorts to clock 20% revenue CAGR in the next 5 years, backed by: 1) enhanced market presence in the domestic tractor market, with expansion of the product portfolio, especially in wetland applications; 2) improved market positioning in Construction Equipment (CE) on widening of the product portfolio, especially in excavators; 3) increased exports by leveraging Kubota’s global distribution network; and 4) commencement of component exports to meet Kubota’s global requirements. We reaffirm BUY with TP of Rs2,450/share (Rs2,500 earlier), based on 25x Dec-24E core EPS (Sep-24E earlier) and cash at Rs397/share (0.80x book).

Q2 EBITDA notably below estimates: Revenue grew by 12% YoY to Rs18.8bn, in line with our estimates of Rs18.6bn. EBITDA declined by 33% YoY to Rs1.53bn, standing 22% below our estimates due to lower-than-expected margins in the Agri and CE segments. EBITDA margin contracted by 540bps YoY (-190bps QoQ) to 8.1% (Emkay est.: 10.5%). Gross margin declined by 650bps YoY (-20bps QoQ) due to higher input costs & discounts. Overall, adjusted PAT declined by 20% to Rs1.42bn, below our estimate of Rs1.51bn, due to lower operating profit. Segmental performance: 1) Agri segment revenue grew 16% to Rs14.5bn led by volume growth of 12% and realization growth of 3%. EBIT margin contracted by 650bps to 8.4%. 2) CE revenue declined by 3% to Rs2.4bn owing to volume decline of 15% and realization growth of 13%. EBIT margin contracted by 620bps to -2.6%. 3) Railways revenue grew by 7% to Rs1.8bn. EBIT margin contracted by 260bps to 14.6%. What we liked: Improvement in domestic tractor market-share to 9.7% vs. 9.3% in Q1FY23 and to 9% in Q2FY22. What we did not like: Weak margin performance in the Agri and CE segments.

Earnings-Call KTAs: i) Tractor industry growth in FY23 is expected to be a mid-to-high single digit. Expectations of a strong Rabi crop should aid customer sentiment. ii) Discounts in the domestic market increased in festive period, with reduction having commenced in Nov-22. iii) Q2 exports grew by 9%, while industry witnessed a decline. It has derived >20% of exports from sales through the Kubota global network. Exports should further increase, on utilization of the network. 4) FY23 CE volume growth is expected in a single digit. The medium-term revenue growth outlook is positive, owing to government thrust on infra spending. 5) The Railways order book is strong at Rs9bn. Mgmt expects robust double-digit growth in FY23. 6) FY23 capex is expected at Rs2.5bn. 7) Medium-term vision plan to be ready in Nov-22.

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