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Overall tractor volume below expectation.

Escorts Kobota Ltd (EKL) is the third largest agricultural tractor manufacturer in India. It has a strong presence in the north and west markets, with a 10.1% market share in FY23.

• Q2FY24 revenue grew by 9%YoY, driven by a superior product mix and price hike. The domestic tractor segment de-grew by -7%YoY, while Construction equipment & Railway registered robust growth.

• EBITDA margin expanded by 476bps (came below our expectations) but declined by 118bps QoQ due to operating deleverage.

• We expect low single digit growth for the domestic tractor segment for the fiscal year. Furthermore, the lackluster performance of exports, is likely to continue in the near term.

• Kubota currently has the majority stake in the EKL and holds 30% of the global tractor market share. This will enable EKL to expand its geographical footprint into the western market.

• The stock is currently trading at 32x and 27x on FY24/F25, respectively. Which is high compared to its 10yr. historical avg. at 15x. We value the company at 25x and recommend Sell rating at CMP

Slow ramp in the export volume

Lacklustre performance in the export market is hindering the ability to offset the cyclicality in the domestic market, which is expected to be in the low single digits due to the high base last year. The company is enjoying a better margin owing to a softening of the metal price and a price hike which was taken over the course of the last year. However, strong growth in construction equipment and Railway has led to a superior product mix. As a result, margins remain resilient above 12-13% for the period. In terms of segmental performance, the Agri sector de-grew by – 5.1% YoY, which constitutes 68% of the overall revenue mix. In the construction equipment segment, demand is expected to increase by double digits for the year on the back of increased govt. spending on infrastructure projects, including smart city development and irrigation projects. We anticipate that growth in material handling and construction machinery will continue in the coming months. The segment grew by 71.5YoY at Rs415cr. In railways, revenue increased by 28.7% YoY, reaching a high of Rs 234cr

Synergies led to expansion globally

EKL’s expanded portfolio & technology upgrades in tractors have resulted in improved numbers both in existing and newer geographies. Strategic collaboration with Kubota has led to an improvement in the global footprint, not only for tractors but also for some export components that are happening in the manufacturing JV. Kubota’s share in the exports is gradually moving up, which is positive for EKL’s ability to sell more in the U.S. and Asia markets. The synergies have lined up a robust capex plan for the long term, but product development will have some lead time due to lower capacity utilization at the existing plant.

Increase in tractor cost and low rural income

Domestic tractor demand is largely dependent on the high crop yield and favourable monsoon, which were uneven due to the flood situation in many parts. The southern market has experienced a decline in monsoons compared to the northern market, which has better irrigation facilities. Moreover, low subsidies from the government also added to the woes. As a result, the adverse product mix has restricted the full realization of the price hike. The company's focus is primarily on high-HP tractors, which are currently in lower demand than low-HP tractors.

Valuations

The stock is trading at its all-time high of 32x due to mid-term optimism and postintegration with Kubota, which are largely factors in the price. We expect the margin to stabilize at its current level due to softening raw material prices and cost control initiatives. However, considering the slow ramp in exports and the loss of pricing power in the domestic market compared to its peers, we expect the nearterm pressure in demand to bring consolidation to the current valuation. Hence, we recommend sell rating at CMP with a revised target price of Rs2,830.

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