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Better gross margins offset by other costs

FY24 tractor industry growth guidance of +/-2% YoY

* 2QFY24 results were inline as better gross margin at 32.3% (vs est. 30.5%) was offset by higher other expenses. The company has guided for flattish growth in FY24 volumes (+/-2% YoY) vis-à-vis ~4% YoY decline in 1HFY24 due to festive mismatch this year followed by erratic rainfall and high base of last year.

* We maintain our FY24E/FY25E EPS estimates. We retain our Neutral rating on the stock with a TP of INR3,000 (25x Dec’25 EPS).

Railway and CE equipment business continue margin expansion

* ESCORTS’ 2QFY24 revenue/EBITDA/Adj. PAT grew ~9%/72%/65% YoY to INR20.5b/2.6b/2.35b (vs. est. INR20.4b/2.7b/2.3b).1HFY24 revenues/EBITDA/adj.PAT grew 12%/67%/79% YoY.

* Tractor volumes declined 7% YoY, while ASP grew 3% YoY (up 1% QoQ) at INR633.1k (vs. est. INR634.9k). ESCORTS’s took a price hike of 1.7% combined in 1Q and 2Q.

* Gross margin expanded 470bp YoY/210bp QoQ to 32.3% (vs est. 30.5%).

* However higher employee costs (+30bps YoY/+180bps QoQ; as a % of sales) coupled with other expenses (+150bps QoQ, as a % of sales) restricted EBITDA margin expansion which stood at 12.9% (+480bps YoY/-110bps QoQ v/s est.13.4%)

* EBITDA grew 72% YoY (-19.5% QoQ) to INR2.6b (vs est. INR2.7b).

* Further high other income led ~65% YoY growth in Adj. PAT at INR2.35b (vs est. INR2.3b).

* FCFF stood at INR4.7b (v/s outflow of INR3b in 1HFY23) led by better operating cash flow of INR5.2b (v/s outflow of INR2b in 1HFY23) and lower capex of INR502m (v/s INR972m in 1HFY23)

Highlights from the management commentary

* Domestic demand- FY24 volume growth to remain flattish (+/-2% growth YoY) led by festive mismatch, high base of last year and erratic rainfall. Believe 3Q growth would be slightly positive despite October being negative and 4Q would see a marginal single digit growth. Demand from commercial segment is 30-35% of overall sales and has been stable over last 18 months.

* Construction Equipment division- FY24 will look similar to 1H growth. Volumes grew ~72% YoY in 2QFY24. Growth driver is on track led by government’s thrust on faster execution of ongoing projects coupled with higher bank credits and positive macros.

* Railway division- Believe to maintain double digit growth this year and next year as well. The company is trying to get into new type of rolling stocks which are being used in Vande Bharat. Also, in terms of margins the company aims to maintain it in the range of +/-100-200bp.

* Capex guidance lowered to INR2.-2.5b for FY24 vis-à-vis earlier guidance of INR3-3.5b. However, part of the capex will move to FY25, hence it might bunch up next year

Valuation and view

* We expect ~2% volume CAGR for tractors over FY23-25E. However, the impact of high base of FY23, reducing subsidies by state governments and the implementation of TREM-4 norms for <50HP tractors (likely in FY25) would be the key monitorables. Faster recovery in other businesses and a ramp-up in its partnership with Kubota would partially dilute the cyclical impact of the tractor industry.

* The stock trades at ~33.9x/29x consolidated FY24E/25E EPS, at a premium to its 10-year average of ~15x, driven by an improvement in operating parameters as well as the Kubota partnership. Moreover, this also reflects possible opportunities arising from Kubota’s parentage viz agri implements, exports, component supplies, etc, as most of these opportunities will become relevant only beyond FY25E. We retain our Neutral stance on the stock with a TP of INR3,000.

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