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Dual impact of market share and margins loss

Valuation and View

Escorts Kubota (Escorts) 2QFY23 results were weak with EBITDA/ Adj. PAT miss by ~28/11% to ours and ~25/3% to street estimates. 2QFY23 witnessed dual impact of RM and non?RM inflation resulting in EBITDA margins to 21 quarter low at 8% (? 190bp QoQ/  ?450bp YoY). Sharp decline in margins explained by 7?year low gross margins at 27.6% (est 29%, ?20bp QoQ), despite price hikes of ~2?2.5%/~2%/~2% in 4QFY22/1QFY23/2QFY23 with product mix largely intact QoQ. Industry growth guidance for FY23 has been revised back to mid?high single digit in. We believe while demand sentiments have been impacted by product price hikes (13?16% over 7 quarters), monsoon spread have been good overall which should help positive farm sentiments.

We believe, Escorts 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 continue dent market share. The valuations at 28x/21x FY23/24 do notreflect, 1) consistent market share loss (despite network expansion and new launches) and 2) weakening margins and growth profile. We believe, benefits arising out of Kubota JV to start reflecting meaningfully only over 2?3 years. We would keenly await managements action plan post Kubota which ESC intend to release by 3QFY23. We cut FY23/24 EPS by ~10/7% to factor in RM inflation. We maintain Reduce on the stock with TP of Rs1,616 (earlier Rs1,648) as we roll forward our TP to June?24 and continue to value co at 15x June?24 EPS. We introduce FY25 estimates and build in revenue/EBITDA/PAT CAGR of 11.4%/16.2%/17.4% over FY22?25E.

Result Highlights – Weak set as EBITDA/Adj PAT 28%/11% below est

* Revenues declined  ?6.5% QoQ (+13.3% YoY) at Rs18.8b. Tractor/CE/railways declined 9%/+5%/?2%.

* Gross margins came in flat QoQ at 27.6% (est 29%), ?590bp YoY. This was led by both RM and non?RM inflation. Co did take price hikes of ~2% even in 2QFY22. Other expense too came in higher at Rs2.2b (est Rs1.96b).  

* Consequently, EBITDA fell 24% QoQ (?27% YoY) at Rs1.5b (est 2.1b) with margins declining by 190bp QoQ at 8.1% (est 11.3%).

* Co reported exceptional charge of Rs728m towards impairment loss in Tedano JV.

* Led by weak op. performance, adj.PAT declined 20% YoY to Rs1.4b (est Rs1.6b)

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