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Escorts Ltd. (EL) reported net sales of INR 19.6 bn in 3Q FY22 (~3% fall over INR 20.2 bn YoY) and a PAT of INR 2.01 bn (down 28.2% YoY). Escorts Farm Equipment (EFE) segment volume declined 19.8% to 25325 units while Escorts Construction Equipment (ECE) segment volume declined 8.2% to 1151 units. EBITDAM (excluding other income) deteriorated by 453 bps YoY (improved 88 bps QoQ) on the back of higher RM cost costs and negative operating leverage. RM cost as % of sales increased 458 bps due to higher metal prices. Operating & Manufacturing Expenses increased 12 bps while employee expenses as % of sales increased 3 bps.

EFE and ECE business performance on expected line, railway equipment business performing well growth during the quarter Tractor industry has now been impacted for two consecutive quarters due to high base of last year, delayed harvest of Kharif crops owing to late monsoon rains this year which affected the rural cash flows and the retail demand. Going forward, we do expect cash flows to improve with better Kharif procurement and positive outlook with good Rabi sowing. CE business reported 22.4% decline in volume yoy (v/s industry decline of 13.5% yoy). ECE segment volume declined by 7.1% while served construction equipment industry volume declined by 35.7%. Railway equipment business reported topline of INR 1.74 bn, registering yoy growth of 48.1%. Orderbook at the end of quarter stood at INR 4 bn.

Partnership with Kubota to add significant value in medium to longer term

Global OEMs such as Kubota can add immense value to the Escorts. Over the medium term, we expect synergies from the partnership with Kuboto to gather momentum including (1) new avenues of growth in construction equipment & agriculture implements leveraging on market leadership across categories, (2) product development, and (3) indigenization of global R&D. These would be underpinned by frugal engineering of Escorts and product design and development expertise of Kuboto.

Other highlights

Domestic tractor demand has been under pressure but is expected to gradually recover on better Kharif procurement and anticipation of good Rabi crop output. Indian tractor industry wholesales are expected to decrease by 4-6% in FY22 and retails are expected to fall by higher levels. The company's dealer inventory stands at 30-35 days, which is lower than the industry average. The average replacement cycle for tractor has come down to ~8-9 years from ~16-17 years over three decades, mainly due to the increase in number of hours of use of tractors. A price increase of ~3% has been taken post the festive season in Dec'21. The total price increase from Nov'20 has been ~10%. Another price hike of 2-3% is expected in Q1FY23. The served industry (Backhoe Loaders, Pick n carry crane and Compactors) has witnessed a fall of 36%/ 15% in Q3/9M. The company has done better with a fall of 8% in Q3, and growth of 23% in 9M. Management expects single to low double-digit growth in FY22 and 15%-20% in FY23. Management expects growth to be ~25% in FY22.

Outlook and Valuation

We see flat growth in tractor volume in FY23. We expect Escorts to continue to gain market share in the tractor segment on the back of inroads in the South and West markets and the benefits from the Kubota. We also expect improvement in margins aided by improving product mix, increasing localisation and benefit of operating leverage. We expect Revenue/EBITDA/PAT to grow at a CAGR of 8.3%/2.7%/6.4% from FY21 to FY23E. At CMP of INR 1838, stock is trading at 25.3x its FY23E earnings. We Recommend HOLD with a revised fair price estimate of INR 1908 in 12 months, 26x its FY23E EPS.

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