Neutral Escorts Kubota Ltd For Target Rs.2,200 by Motilal Oswal Financial Services Ltd
Double-digit volume decline expected in 2H Margin headwinds to persist till 4QFY27
* Escorts Kubota’s (EKL) 2QFY27 PAT at INR2.6b missed our estimate of INR3.1b due to lower-than-expected margins and other income. While construction equipment margins surprised positively, tractor margins disappointed.
* Management has cut its tractor volume guidance to a marginal singledigit decline (from mid-single growth earlier) in FY27, implying a doubledigit decline in 2HFY27 for the industry. Further, margins are expected to remain under pressure in 3Q and then gradually normalize as input costs cool off in 4Q and the latest price hikes are fully reflected. Hence, due to near-term headwinds for the tractor industry, which could potentially stretch into the next fiscal, we have cut our earnings estimates by 8%/3% for FY27E/FY28E. We estimate EKL to post a CAGR of 5%/-1%/3% in revenue/EBITDA/PAT over FY26-28E. While synergies between Escorts and Kubota are significant, they will likely materialize over the medium to long term. The stock appears fairly valued at ~21.8x/18.9x FY27E/28E EPS. We reiterate our Neutral rating on the stock with a TP of INR2,200, based on ~17x FY28E EPS.
PAT miss due to lower other income resulting in a weak quarter
* 2Q standalone revenue came in line with our estimate at INR32.3b, up ~16% YoY (+1.7% QoQ). Growth was driven primarily by 10.1% YoY improvement in net realizations to INR791k per unit, whereas volumes were flat YoY at 34k units.
* Gross margins declined ~370bp YoY to 27% (-20bp QoQ), primarily due to RM cost inflation.
* As a result, EBITDA margins fell 400bp YoY to 9.1%, below our estimate of 10%. EBITDA declined 19.5% YoY to INR2.9b (below est. of INR3.1b).
* Tractor margins contracted ~505bp YoY to 7.8% (below est. of 9.8%). Construction equipment margin expanded 410bp YoY to 7.9% (above our est. of 5.5%), supported by higher volumes, operating leverage and calibrated price increases.
* Other income was much lower than expected at INR1.2b (est. INR1.8b).
* As a result, PAT missed our estimates, down ~21% YoY to INR2.6b.
* In 1HFY27, CFO stood at INR46m, while free cash outflow was INR1.2b.
Highlights from the management commentary
* Following strong 1QFY27 growth, demand has moderated, with management revising FY27 industry guidance to low-single-digit decline, implying double-digit contraction in 2HFY27 amid El Niño-related rainfall concerns, lower reservoir levels and reduced subsidies.
* EKL is well positioned to benefit from stable infrastructure activity. CE industry growth is expected to moderate to 15-16% in 2HFY27 from ~20% in 1H. However, improving operating leverage and pricing discipline should support margin sustainability.
* Commodity inflation is a key margin headwind, with input cost inflation rising to 8-9% by 2Q end and a further 2-3% impact expected in 3Q, alongside high manpower and conversion costs. Margin pressure could ease after 4QFY27.
* EKL has cumulatively raised tractor prices by ~3.5% in FY27 so far and announced a further 3-3.5% increase effective mid-Nov’26, taking cumulative hikes to 6-7%. The full benefit of the latest hike should reflect in 4QFY27, supporting margin recovery.
* EKL plans normal capex of INR3.5b in FY27 and INR3b in FY28, alongside INR4- 4.5b for land acquisition and a phased greenfield investment of ~INR20b over 3-4 years to expand tractor, construction equipment and parts warehousing capacity.
Valuation and view
Management has cut its tractor volume growth guidance to a marginal single-digit decline (from mid-single growth earlier) in FY27, implying a double-digit decline in 2HFY27 for the industry. Further, margins are likely to remain under pressure at least in 3Q and then gradually normalize as input costs cool off in 4Q and the latest price hikes are fully reflected. Hence, due to near-term headwinds for the tractor industry, which could potentially stretch into the next fiscal, we have cut our earnings estimates by 8%/3% for FY27E/FY28E. We estimate EKL to post a CAGR of 5%/-1%/3% in revenue/EBITDA/PAT over FY26-28E. While synergies between Escorts and Kubota are significant, they will likely materialize over the medium to long term. The stock appears fairly valued at ~21.8x/18.9x FY27E/28E EPS. We reiterate our Neutral rating on the stock with a TP of INR2,200, based on ~17x FY28E EPS.
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