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Weak margins despite better volumes

Valuation and View – Margins normalcy still sometime away

Escorts Kubota (EKL) 3QFY23 results were weak with EBITDA/ Adj. PAT miss by ~20%/10% to ours and 17.5%/5% to street estimates. The quarter continued to witness dual impact of RM and non-RM inflation under recoveries resulting in EBITDA margins at 8.4% (+30bp QoQ/ -570bp YoY). This is despite, tractor/CE/railways revenues grew 17%/37%/26.5% QoQ. Weak margins explained by 1) production/sales timing mismatch between 2Q/3Q impacting operating leverage (1-1.25% impact), 2) lag impact of Nov’22 price hikes leading to unabsorbed under recoveries of 1-1.5% and 3) RM decline in castings/tyres were lower v/s steel.

We believe, EKL is more vulnerable v/s peers as i) it derives >80% of its revenues from FES segment and ii) aggressive expansion plans by Sonalika, TAFE, John Deere, etc. to keep tight balance between market share and margins priorities. The valuations at 19x/15x FY24/25 do reflect upon anticipated market share expansion. We believe, benefits arising out of Kubota JV to start reflecting meaningfully only over 2-3 years. We largely maintained FY24/25 EPS and maintain Neutral on the stock with TP of Rs1,996 (earlier Rs1,983). We continue to value co at 17x Sep-24 EPS. We build in revenue/EBITDA/PAT CAGR of 14%/19%/21% over FY22-25E.

Result Highlights – Weak as EBITDA/Adj PAT 20%/10% below est

* Revenues grew 20% QoQ (+14.8% YoY) at Rs22.7b. Tractor/CE/Railways revenues grew 17.4%/+26.5%/+37% QoQ backed by volume and price hikes.

* Gross margins came in at 25.5% (est 28.7%), -480bp YoY (-210bp QoQ). This was led by under recoveries on metal/non-metal inflation (~1-1.5% under recoveries) Co took price hikes in Nov’22 (flowed by ~7-8% hikes over 3-4 quarters) which is expected to reflect positively in 4QFY23E

* EBITDA grew 24.7% QoQ (-31.7% YoY) at Rs1.9b (est 2.4b) with margins came in at 8.4% (est 10.8%, -570bp YoY and +30bpp QoQ).

* Segmental EBIT margins - Agri at 8.3% (-10bp QoQ), Railway at 14.6% (-150bp), CE at -2.2% (v/s +2.2%).

* Led by higher other income at Rs913m (est Rs810m) and lower tax at 22.8% (est 25%), Adj. PAT grew 32% QoQ (-8% YoY) at Rs1.86b (est Rs2.1b).

* 9MFY23 performance – Revenue/EBITAD/Adj. PAT grew 16%/-25%/-15.6%

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