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Cost inflation impacts performance

Management expects mid-single digit growth for Tractors in FY22

* ESC’s 4QFY21 operating performance was impacted by commodity cost inflation, but was partially offset by operating leverage benefits in other businesses. While its near term demand outlook looks weak due to sporadic lockdowns, the management expects a strong recovery post lifting of lockdown restrictions, leading to mid-single digit growth guidance for the Tractor industry in FY22.

* We cut our FY22E/FY23E EPS by 9%/7% to factor in weaker volumes and higher RM cost. We lower our target P/E multiple to 14x (from 15x earlier and at a premium to its five-year average of 12.4x) to factor in near peak cyclical earnings in FY23E. Maintain Neutral with a TP of INR1,300/share (~14x Mar’23E consolidated EPS).

Better mix, lower marketing, and other expenses support margin

* Revenue/EBITDA/PAT grew 60/%/77%/93% YoY in 4QFY21 to ~INR22.1b/INR3.45b/INR2.7b. The same in FY21 grew 20%/67%/77% YoY to INR69.3b/INR11.3b/INR8.7b.

* Tractor volumes grew ~62% YoY. Net realizations improved 1.4% YoY (~2% QoQ) to INR533.6k (est. INR527.4k) due to price hike (~2% in Nov’20) and favorable mix (contribution of over 40HP Tractors at 60%). Revenues for Tractors/Railways/Construction Equipment grew 64%/36%/53% YoY.

* EBITDA margin declined ~245bp QoQ (+150bp YoY) to 15.6% (est. 16.9%), impacted by higher RM costs, but was partially offset by better product mix, cost optimization initiatives, and operating leverage.

* PBIT margin for Tractors fell 310bp QoQ (+120bp YoY) to 17%. The same for the Railways/CE business grew to 19%/7% (+510bp/+300bp YoY).

Highlights from the management commentary

* Outlook: While all macro/farm economic indicators and availability finance positive, impact of the COVID-19 pandemic in rural India can act as a dampener. Currently, two-third of dealers are either closed or open for limited hours. Hence, the management expects FY22 industry growth at mid-single digits.

* Markets are expected to open up by the end of May’21 or early Jun’21. Even if markets open up in late Jun’21, demand will bounce back due to strong underlying demand drivers.

* Tractor business to post steady state PBIT margin of 17-18%. However, considering higher cost inflation, margin in FY22 may be 100-150bp lower than the new range.

* Tractor demand from the non-Agri segment (30-35% of total volume) to pick-up in FY22, which would be the key contributor to its growth guidance. It expects no material support from government subsidy for Tractor sales.

* Exports of e-Kubota branded Tractors through Kubota’s global network began from 4QFY21 in four markets. It would add more markets and expects volumes to really pick-up from FY23.

* Management will unveil plans for use of its cash in the next one month.

Valuation and view

* Valuations at 13.8x/12.5x consolidated EPS largely reflect strong growth and its partnership with Kubota. The stock is trading at a premium to its 10-year average of 10x. We lower our target P/E multiple to 14x (from 15x earlier and at a premium to its five-year average of 12.4x) to factor in near peak cyclical earnings in FY23E. We maintain our Neutral stance with a TP of INR1,300/share (14x Mar’23E consolidated EPS).

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