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Robust capital efficiency, healthy b/s merit upgrade

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’s CAGR: 44.9%, 59.8% in EBITDA, PAT; cash positive b/s

Q2FY22 Results: The company posted a decent Q2FY22 performance.

* Total operating income at | 1,622 crore was up 1.4% YoY

* EBITDA margins declined lower than expected, by 131 bps QoQ to 12.6%

* PAT declined 24.5% YoY to | 173 crore

What should investors do? The share price of Escorts has grown ~4x over last five years from ~| 380 levels in October 2016, vastly outperforming Nifty Auto Index.

* We upgrade Escorts to BUY amid robust capital efficiency, net cash b/s

Target Price and Valuation: We value Escorts at revised SOTP-based TP of | 1,900 (20x P/E on core FY23E EPS, 20% discount on treasury shares; previous TP | 1,325)

Key triggers for future price performance:

* Expect ~13% tractor revenue CAGR over FY21-23E (5.5% volume CAGR), constrained by high installed base despite favourable macro tailwinds

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

* Operating leverage gains to expand EBITDA margins to ~14% by FY23E

* Optimum utilisation of surplus cash on b/s, possible stake increase by Kubota Corporation (currently 10%) could be a large value driver

Alternate Stock Idea: Apart from Escorts, in our auto OEM coverage we like M&M.

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

* BUY with target price of | 1,000

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