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Margin came below estimate

Escorts Kobota Ltd (EL) is the third largest agricultural tractor manufacturer in India. It has a strong presence in the north and west markets, with an overall market share of 10.3% as on FY22.

• Q2FY23 revenue grew by 13%YoY, driven by 12.5% volume growth in the tractor segment. While, sales from the construction equipment's down by 14.6%YoY.

• EBITDA margin came in below our expectations at 8% due to inflation, elevated commodity prices and increase in other costs.

• Despite 12%YoY growth in the strong northern market, intense competition in the southern market is dragging down volume and restricting the full pass-through of the inflated commodity price.

• However, EL’s strategic initiative with Kubota for export will drive growth in the long term for higher HP category. The company also outlined a capital expenditure of Rs.350-400 crore this financial year.

• On a 1yr. Fwd, the stock is trading at its all time high of 26x. However, considering the margin pressure and lower volume for H2, we downgrade our estimate and recommend Sell rating at CMP.

Margin came below estimate.

Revenue for the quarter came in at 1,883cr, driven by growth in the tractor volume by 12.5%YoY, but QoQ down by 13% to 21,396 units. Export volume grew by 9% to 2,307 units. Regionally, Maharashtra & Madhya Pradesh performed well but the North central & eastern market suffered from an erratic monsoon. In construction equipment's, volume was adversely affected due to lower economic activity and margin contracted due to surge in commodity price. In railway, company registered record sales of Rs.182cr.(+7% YoY). We expect the volume’s to rise due to the government’s push in infrastructure. In railway, tendering as picked up and current order book stands at Rs9bn. (Rs8.5bn last year) which will be executed in the subsequent quarters. Despite 70bps increase in market share for the quarter margin came below expectations due to unabsorbed inflation & commodity price hike and increase in other cost. As a result PAT de-grew by -9.2% YoY.

JV with Kubota will expand geographical footprints.

EL’s expanded portfolio & technology upgrades in tractors have resulted in improved numbers both in existing and newer geographies. Exports have grown by 26%YoY in H2FY23 and expect the same trend to continue for the full year. Strategic collaboration with Kubota has led to a higher global footprint. Contract manufacturing of EL and Kubota products under the brand “E Kubota” is expected to commence by the next quarter with an outlay of 30,000 capacity. On the domestic front, we are forecasting a moderation in the tractor volume growth in H2FY23E, due to lower government subsidy and demand for low HP category owing to unprecedented situation. However, higher export & growth in the non farm sector will drive revenue growth in the long term.

Margin to show some resilience at later half.

In the last 3-4 quarters, the commodity cost has increased by ~35% and the full cost benefit is not achieved due to industry pressure. The company raised price of ~2% for the quarter and still some under recovery of ~5% is needed to get the normal benefit. Despite subsequent price hike we expect the margin to remain under pressure for near term and expect to show some resilience in H2, owing to industry recovery and through operating leverage. We lower our margin expectation for FY24 by 190bps to 13.2%.

Valuations

Overall rural sentiments are positive because of a normal monsoon and high crop yield. However, intense competition in the low HP tractor, higher discounts, inflation and limited government subsidies for FY23 have led to deferring certain capex for the current fiscal year. The stock is trading at its all time high of 26x which is above its historical avg. of 18x. However, we believe, the stock is likely to trade in premium owing to Kubota corp. holding major stake. Considering the near term headwinds and margin pressure, we maintain our valuation at 20x on FY24E EPS with a target price of Rs. 1,783/share and recommend sell rating at CMP.

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