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Neutral Escorts Ltd For Target Rs.1,270

Above our estimate; a strong showing in Tractors, but the cycle is turning

Single-digit growth in FY22 implies a residual decline in single-digit

* Operating performance in 1QFY22 was driven by strong growth in the Tractor business (benefitting from the mix). The demand outlook is turning murky, which raises uncertainties over the next 12-15 months, though Kubota JV, leaner cost structure, recovery in the Railways/Construction Equipment, and a strong Balance Sheet will dilute impact on the P&L.

* We cut our FY22E/FY23E EPS by 2%/11% to factor in weaker volumes. We maintain our Neutral stance with a TP of INR1,270/share (14x Sep’23E consolidated EPS).

Higher other income boost adj. PAT

* Revenue/EBITDA/PAT declined by 24%/32%/32% QoQ (+57%/ 95%/ +101% YoY) in 1QFY22 to ~INR16.7b/INR2.3b/INR1.85b.

* Tractor volumes declined by 20% QoQ (+43% YoY). Net realizations improved by 2% QoQ (+3.6% YoY) to INR544.2k (est. INR539k) due to price hikes. Revenue from Tractors/Railways/Construction Equipment fell 19%/18.5%/56% QoQ.

* EBITDA margin declined by ~160bp QoQ (+270bp YoY) to 14% (est. 12.5%), impacted by operating deleverage.

* PBIT margin for Tractors fell 140bp QoQ (+110bp YoY) to 15.6%, despite a 20% QoQ volume decline. PBIT margin for the Railways business fell 450bp QoQ to 14.6%. PBIT margin for Construction Equipment was negative at 2.3% (v/s 7.3% in 4QFY21).

* Higher other income boosted adjusted PAT to INR1.85b (est. INR1.49b), a decline of 32% QoQ (+101% YoY).

Highlights from the management commentary

* Outlook for Tractors: Volumes in May-Jul’21 grew 6% YoY. It has guided at a low single-digit growth for the industry (to grow for the next 3-4 months and then decline), with ESC to grow faster than the industry.

* ESC dealer inventory (at 30 days) continues to be lower than the industry average of 45-50 days.

* RM cost inflation and price hikes: With the price increase in Jul’21 (third price hike in the last nine months), it has completely passed on all commodity cost inflation witnessed till Jun’21. It expects a further inflation of 2% in 2QFY22 and expects to pass it on with a lag.

* It expects exports to the Kubota network to ramp-up in FY22/FY23, as the current higher exports of ESC are through its own network.

* New emission norms for over 50HP come into effect from Apr’22 (v/s earlier Oct’21) and for all Tractors (over 25HP) from Apr’24. The management doesn’t expect further postponements.

* The share of over 40HP Tractors remains at higher levels (~60%). As the share of non-Agri Tractor sales pick-up, it expects the mix to normalize.

* The Railways business: It expects 13-14% growth and stable margin at FY21 levels of 16%. The Indian Railways is still not running its entire operations and has cut down its annual production rate, affecting fresh order tendering and order inflow. ESC’s railway order book was over INR3b as of Jun’21 (v/s INR4.8b in 1QFY21).

* Cash: The company is looking at M&As (for instance, in the Railways segment) and will use the cash on its Balance Sheet to fuel its growth aspirations.

Valuation and view

* The stock trades at 14.6x consolidated FY2E3 EPS, which is at a premium to its 10-year average of 10x due to an improvement in operating parameters as well as the Kubota partnership. Considering the Tractor cycle is nearing its peak and risk of a slowdown, we maintain our Neutral stance with a TP of INR1,270/share (14x Sep’23E consolidated EPS).

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