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Escorts Ltd. (EL) reported net sales of INR 16.6 bn in 2Q FY22 (~1.4% increase over INR 16.4 bn YoY) and a PAT of INR 1.76 bn (down 23.1% YoY). Escorts Farm Equipment (EFE) segment volume declined 13.8% while Escorts Construction Equipment (ECE) segment volume increased 30.8%. EBITDAM (excluding other income) deteriorated by 571 bps YoY (-131 bps QoQ) on the back of higher costs and negative operating leverage. RM cost as % of sales increased 299 bps due to higher metal prices. Operating & Manufacturing Expenses increased 198 bps while employee expenses as % of sales increased 74 bps.

ECE and railway equipment business drives growth during the quarter

Escorts Ltd reported tractor revenues of INR of 12.5 bn. Company expects domestic tractor industry volumes to remain flattish (from earlier expectations of mid-single digit growth) on a yoy basis in FY22 as Q2FY22 was negatively impacted due to delay in onset of monsoon, which impacted the sowing season. CE business reported strong volume of 31% yoy (v/s industry decline of 15% yoy) and topline of INR 249 cr, higher by 59% yoy. EBIT margin stood at 3.6% vis-à-vis 1.7% in Q2FY21. Railway equipment business reported topline of INR 170 cr, registering yoy growth of 6% and EBIT margins of 17% v/s 20% in Q2FY21.

Expect strengthening in partnership with Kuboto

Global OEMs such as Kubota can benefit by strengthening partnership in terms of gaining access to the Indian FE and CE markets. Over the medium term, expect synergies from the partnership with Kuboto to gather momentum including (1) new avenues of growth in construction equipment & agriculture implements leveraging on market leadership across categories, (2) product development, and (3) indigenization of global R&D. These would be underpinned by frugal engineering of Escorts and product design and development expertise of Kuboto. Further, proceeds from preferential allotment would be used towards new product development as well as towards investment in capacities at Escorts Kubota India Pvt Ltd (40% JV).

Other highlights

FE Volumes were lower in Q2 due to a high base (pent-up demand last year) and erratic rainfall. Lower rainfall in Jul-Aug'21 and excess rainfall in Sep'21 damaged the crops and delayed the harvesting cycle by 3-4 weeks in certain parts of the country Domestic tractor market share was lower by 80bps yoy to 9% in Q2. The geography mix was adverse as the West and South regions performed better than the North and Central regions. Tractor growth will be plus or minus 2-3% YoY in FY22; rural sentiments are strong. November demand should recover. Non-farm sales of tractors were subdued last year and improving this year. Discounting is back to normal; supply has been normalised. Dealer inventory for Escorts is lower than industry; by November will be back to normal inventory of 25-30 days. Price hikes were taken in Nov 20, April 21 and July 21. This was cumulative hike of 7-8%. Management wanted to take price hike in Oct-21 but decided to wait. Price hike of around 3-4% will happen after the festive season. Management expects 15-17% revenue growth on a yoy basis and operating margins in the range of 16-18% in FY22. Pickup in the ordering activities by Indian Railways to drive growth. New products contributed 64% as compared to 58% YoY. Capex will be ~INR 300-325 cr in FY22.

Outlook and Valuation

Tractor industry remains relatively well placed in current environment. We expect Escorts to continue to gain market share in the tractor segment on the back of inroads in the South and West markets and the benefits from the Kubota. We also expect improvement in margins aided by improving product mix, increasing localisation and benefit of operating leverage. We expect Revenue/EBITDA/PAT to grow at a CAGR of 11.9%/6.5%/10.2% from FY21 to FY23E. At CMP of INR 1629, stock is trading at 21x its FY23E earnings (vs average of 20.8x for last 5 years). We Recommend HOLD with a revised fair price estimate of INR 1654 in 12 months, 21x its FY23E EPS.

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