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Focus on comprehensive growth through synergies

Market share gains, product launches, and exports to be the key focus areas

Escorts Kubota (ESCORTS) hosted the investing community, followed by the plant visit at its Faridabad facility, where the entire senior management presented their mid-term strategy (till FY28E) and focus areas (link to the presentation). The company is now focusing on leveraging strong synergy benefits for a comprehensive growth across business areas. The company’s focus would revolve around a) growing market share in India (through new product launches and channel expansion), b) attaining leadership position in exports (through product developments), c) continuing with the ramp-up of other businesses, and d) improving profitability.

* Aims to increase market share: ESCORTS targets to achieve a market share of 18-20% (including Kubota) by FY28E, up from its current 12- 13%. This will be driven by i) product expansions (1.5x to 3x) across all three brands (Powertrac, Farmtrac, and Kubota) ranging between 15HP and 110HP and ii) channel expansion by 50% from its current network of ~1,400 dealers (including ~300 for Kubota brand) along with an opportunity for existing dealers to become multi-brand retailers. Kubota has manufacturing plants in Japan, Thailand, America, and EU. The company is of the opinion that there is still some scope for improvement in the quality of products placed in domestic markets.

* Attain leadership position in exports: ESCORTS aims to increase its exports contribution to 15-20% of the overall revenue by FY28E from its current ~6.4%. The company is targeting four key high volume markets - USA, Europe, Thailand, and Brazil and intends to leverage Kubota’s strong presence in key markets such as North America (~1200 dealers) and Europe (~300 dealers). It will also work with multi-brand vendors in markets such as Africa and South America. The company plans to strengthen its EV portfolio for mature markets and channel expansion will be further complemented by product expansion (~2x) across all the brands.

* Aims to be the challenger brand in domestic tractor market: The management indicated a huge scope for growth in the domestic agrimachinery market. Kubota can launch some of its major brands in India going forward. Penetration of rice transplanters in India is at less than 20%. Kubota has launched rice transplanters of ~70HP, which is suitable for the Indian market due to smaller size farms. It has launched only two products so far and multiple launches can be expected in the future.

* Expect EBITDA to improve to mid-teens by FY28: The management expects EBITDA to improve driven by i) softening of RM basket and ii) benefits of scale after the Escorts-Kubota tie-up. However, the company expects EBITDA margin to dilute by ~2%, post the merger of two JVs (manufacturing and marketing JVs) as their margins still remain subdued. However, once the integration is completed, margins are expected to improve, led by cost savings. Further, it expects return ratios such as ROCE (pre-tax) and ROE to improve to 25-30% and 18%, respectively, by FY28 from 17% and 13% now.

* Global sourcing to create new opportunities for India: Worldwide value of components purchased by Kubota stands at USD8.7b, wherein major sourcing is from China and Thailand. Even sourcing just 5% of its total components from India would mean USD500m of potential exports for the country. Most of the sourcing for Kubota is localized, except engine (~33% of the product). Other target items would be i) in-house fabricated assembly items such as transmission, gears, and assemblies, and ii) castings, gears, and function parts.

* Construction Equipment (CE) - Aspire to double market share: ESCORTS currently addresses ~54% of the total CE industry. It aspires to be the market leader in Material handling and Mini excavator segments by doubling its domestic market share. Also, it plans to expand geographically by i) doubling its domestic channel and ii) expanding to ~35 countries (from its current ~20 countries).

* Railways - Targeting ~3x revenue growth over the next six years: The company expects revenue to be driven by i) current product expansion (largely in exports), and commercializing many products, under field trial, over the next one to two years, ii) increasing capacity to cater to the new demand, and iii) targeting new segments such as semi-high speed (Vande Bharat), metro, and private wagon builder. The segment currently has a record order book of INR9B in Sep-22 (v/s INR4.4B in Mar-22).

* Retail finance to be strengthened: ESCORTS aspires to establish its own captive NBFC arm. It has partnered with most of the leading banks and NBFCs including key regional players and will continue to add new partners at both national and regional levels. Going forward, it might try a tie-up model or opt for separate financing. It currently has over 35 MoUs and most of them are with public banks.

* Focus on emerging business intensifies: The company aims to grow its i) industrial engine revenues by 9x and ii) spares sales by ~2.4x. Within engine application, the company looks to grow in the 5-25HP segment and increase its manufacturing capacity to 3L from 1.7L engines. Also, it plans to introduce hybrid and alternate fuel engine with Japanese and Indian technology coming together. Also, it is planning to enhance capacity by setting up a huge global parts center in India and setting up regional distribution center.

* Capital allocation - Aims dividend payout of ~40% by FY28: The management has guided capex of INR35-40b (over FY23-28E) for its core business, which will be utilized toward i) greenfield capacity expansion, ii) expanding vendor capabilities, and iii) product innovation & technology. Moreover, the annual capex target has been revised to INR3B for FY23 (from INR2-2.5B) and should increase further in FY24. About 5% of the net profit will be utilized toward R&D and innovation (over and above normal R&D) largely for new startups. Since the merged entity would have a debt component of INR4-5b at the time of merger, and it would be repaid soon. ESCORTS targets a dividend payout (including buyback) of ~40% of net profit by FY28 (v/s its current ~20%). Globally, Kubota’s dividend payout stands at ~40% and it aspires a ~50% by FY25.

* Valuation & view: ESCORTS has intensified its focus on comprehensive growth across its business verticals. While the mid-term growth strategy seems to be in the right direction, we would watch for its effective execution. Seamless execution in targeted areas such as i) market share gains in the domestic tractor industry, ii) growth in exports through Kubota channel, iii) benefits of sourcing/localization, and iv) recovery in margins (in-turn) would be the key monitorables. However, in the near term, we believe uncertainty in the tractor cycle would continue, led by an anticipation of a sharp inventory correction in 3Q and the adverse impact of implementation of TREM-4 norms for >50HP tractors from Jan-23. This, along with a high base of FY23, would keep volume growth under check in the foreseeable future. Faster recovery in other businesses and a ramp-up in its partnership with Kubota would dilute the impact of a weaker Tractor cycle on ESCORTS. The stock trades at ~24.9x consolidated FY24E EPS, at a premium to its 10-year average of ~12.6x, driven by an improvement in operating parameters as well as the Kubota partnership. While the tractor cycle seems to be uncertain, the valuations are already reflecting volume recovery as well as the benefit of Kubota partnership. We reiterate our Neutral rating with a TP of INR1,875 (20x Dec’24E consolidated EPS).

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