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Tractors margins continues to disappoint

View – Recent stock correction yet not make risk reward favorable

Escorts Kubota (ESCORTS) 3QFY25 results were weak though reported numbers are not comparable as Railways division (RED) is shown as discontinued operations. While CE/RED business performance was in-line, lower than expected margins in FES led EBITDA margins at 11.4% (-50bp YoY/ +110bp QoQ, est 12.9%) continues to disappoint. Margins expansion for the merged entity to likely be gradual given full benefits of localization etc. to only kick-in over 1-2 years. However, improved volume outlook on tractors, new launches and fading impact of higher discounting should help margins expansion QoQ. We believe, ESCORTS can surpass co guidance of mid-single digit industry volume growth for FY25E with large part of inventory destocking done and early sings of volume stability in North markets (key markets for Escorts) to be supported by new launches in Farmtrac. While we remain constructive on growth opportunities for merged entity in tractor, implements, components sourcing and exports to synergize only over mid-term, near term margin recovery to be only gradual. We see EKL’s market share remain range bound.

We believe, EKL is more vulnerable v/s peers as 1) it derives ~75% of its revenues from agri segment and 2) aggressive expansion by Sonalika, TAFE, John Deere, etc. necessitating tight balance between market share and margins. Despite recent correction, the valuations at 30.3x/26.3x FY26/27 EPS, do reflect positive synergies making risk reward yet not favorable. We believe, benefits arising out of Kubota to start reflecting meaningfully led by exports ramp-up (FY26E) and localization (FY27E). We cut FY26/27 EPS by ~1-3% each to factor in for weaker margins. Maintain Neutral with revised TP of Rs3,643 (vs Rs3,752). We value co at 29x Mar’27 EPS (unchanged) and build in revenue/EBITDA/PAT CAGR of 15.4%/14.9%/13.6% over FY24-27E.

Result Highlights – Weak operating performance

* Revenues grew 8.5% YoY (+29.6% QoQ) at Rs29.4b as Agri/construction equip (CE) revenues grew +9.4%/+4.1% YoY. Tractor ASP grew 3.3% YoY (+1% QoQ) at Rs732k/unit while vols grew ~4.5% YoY (+25.2% QoQ) at ~32.6k units.

* Gross margins came in at 26.9% (-60bp YoY/-340bp QoQ). Weak gross margins were led by normalized impact of production, RM inflation (~50bp) and higher discounting due to festive. EBITDA came in at Rs3.35b (+3.5% YoY/+44% QoQ) with margins at 11.4% (-50bp YoY/+110bp QoQ).

* Segmental EBIT margins – Agri at 10.4% (-160bp YoY/+130bp QoQ), CE at 9.3% (+170bp YoY/+290bp QoQ), RED at 21.5% (+310 YoY/ +630bp QoQ).

* Adj.PAT to grew 7.7% YoY (-3.8% QoQ) at ~Rs2.9b.

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