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Tractor demand set to revive from H2

Positives seem priced in

* Escorts Kubota’s (ESCORTS) 2QFY25 operating performance was stable YoY as the company reported flattish revenue/EBITDA growth YoY. The recent amalgamation with group companies has led to 150-200bp margin dilution for the business, given the higher mix of imports.

* To factor in for the same, we have cut our EPS estimate by ~11% for FY26E, keeping FY25E the same. The recent divestment of its Railways business on a slump sale basis to Sona Comstar did not sit well with investors, who were left surprised with the decision to divest a solid business at cheap valuations. We retain a Neutral rating on the stock with a TP of INR3,560, based on ~28x Sep-26 EPS

Amalgamation likely to dent EBITDA margin by 1.5-2%

* Results cannot be compared with our estimates as the financials reflect restatement due to amalgamation.

* Revenue grew ~0.5% YoY to INR24.8b, driven by 5% YoY growth in agri machine products, while revenue from the railway equipment/construction equipment division declined 10%/14% YoY.

* 1HFY25’s revenue/EBITDA/PAT grew ~10%/7%/27% YoY. For 2HFY25 we expect the same to grow ~34%/18%/19%.

* Gross margin during the quarter expanded 70bp YoY/ 90bp QoQ to 30.8%. However, this was offset by higher operating expenses, resulting in flattish YoY EBITDA margin at 10.8% (-240bp QoQ).

* The management highlighted that the amalgamated companies contribute INR20b to the annual topline with breakeven margins, leading to a 1.5-2% margin dilution initially, given the high mix of imports.

* PBIT for agri machinery/railway equipment/construction equipment contracted 20bp YoY/330bp/60bp YoY to 9.1%/15.2%/9.3%, respectively.

* Led by higher other income and lower tax, Adj. PAT for the quarter grew ~53% YoY to INR3.3b.

* CFO/FCF for the quarter grew ~18%/27% YoY in 1HFY25.

Highlights from the management commentary

* Domestic demand outlook: Optimistic about the 2HFY25 demand, the company expects double-digit growth in 2H and about 5% growth for FY25.

* Post-merger, the non-tractor revenue in Agri Machinery now contributes around 17-19% of the overall Agri revenue, up from 10- 12% previously. Integration with ESCORTS will help reduce overheads from the current 10-11% level, with initial target to expand margins to around 13%. Moreover, post the localization benefits, margins can further inch up to mid-teen levels in the long run.

* RM basket: In 2Q, inflation was nominal. Though tire prices have risen, this will not cause major disruptions. Input costs are likely to remain stable YoY.

* Exports: The company’s initial focus is on Mexico and Southeast Asia, with products expected to be ready for the EU market by the end of FY24. Exports are likely to pick up by Q4FY25 onwards. Exports to the US and South America depend on the greenfield facility and are likely to take longer.

Valuation and view

* The demand for domestic tractors is improving, with FY25 volumes expected to grow by mid-single digits, driven by a healthy monsoon, favorable crop prices, and government support. However, its recent amalgamation with group companies has led to 150-200bp margin dilution.

* To reflect this, we have reduced our FY26E EPS estimate by ~11% while maintaining FY25E. While synergies between Escorts and Kubota are significant, they will likely materialize over the medium to long term. The recent divestment of its Railways business on a slump sale basis to Sona Comstar did not sit well with investors, who were left surprised with the decision to divest a solid business at cheap valuations. The stock is trading at a premium of ~36x/32x FY25E/26E EPS, compared to its 10-year average of ~18x, mainly due to the Kubota parentage. We maintain a Neutral stance with a TP of INR3,560 (28x Sep’26 EPS).

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