Escorts Kubota Limited: Research Report at a glimpse

Stock Data:

Ticker	ESCORTS
Exchange	NSE and BSE
Industry	Auto – Tractors & Construction

Price Performance:

Last 5 days	-2.63%
YTD	-14.30%
Last 12 months	35.81%

Why is the stock price falling?

The stock price nosedived more than 5% after reporting weak results on Aug, 2, 2022. The company registered a 20.35% decline in its standalone net profit to INR 147.5 crore in the quarter ending June 30, 2022 compared to a profit of ₹185.2 crore in the corresponding quarter of the previous fiscal. This steep decline in bottom line was due to lower operating profit as steep inflation in commodity prices coupled with adverse product mix took a toll.  On the other hand, the revenue from operations soared to ₹2,014.9 crore in Q1FY23 against ₹1,677 crore in the same period last year.

The company declared a final dividend of INR 7 per share on 13 May 2022 which will be effective from 30 June 2022.

Global research and broking firm CLSA has downgraded Escorts stock to “sell”, with a revised target price of INR1,612. The brokerage house said the “big miss on margin led to a negative surprise”.

The brokerage firm has cut earnings estimates by 24%-26% over FY23-24 on a 7% lower volume forecast and 400 bps cut in EBITDA margin.

Management commentary:

We are excited to be Escorts Kubota Limited (EKL) now. During the first quarter of the current fiscal industry the Agri sector has witnessed a positive trend, after 3 quarters of degrowth. With onset of monsoon, and likely record Kharif crop production, rural liquidity and farmer sentiments are expected to gradually improve. In our construction business, we have outperformed the industry in our served markets and expect growth momentum to continue with the Government’s thrust on infrastructure development.

-Nikhil Nanda, Managing Director

Preferential Issue: 

During FY22, the company allotted 93.6 lakh shares at a price of INR 2000 per share to Kubota Corporation for a total consideration of 1872 crores. Subsequently, Kubota issued an open offer to acquire further stake in Escorts. After the conclusion of the preferential issue and the open offer, Kubota holds 44.8% stake in Escorts.

Recent Developments:

During FY22, the company launched six new tractor variants under the Powerhouse series with improved power, fuel efficiency, application suitability and lower maintenance features. Under the railways equipments vertical, the company launched Emergency pull box, Coupler (Rev # 3) and Metro Dampers (Chennai Metro). 

Competitive advantage:

Escorts operates in an industry where there is a cut throat competition and hence it creates a massive entry barrier for new entrants. The board is quite innovative and has good capital allocation skills which is why they have been able to generate a lucrative ROCE as compared to its peers. Due to such factors the company has been able to gain a significant market share over the years.

Product Category	Escorts market share 2015	Escorts market share 2021
< 30 Horsepower Tractors	1.9%	6.7%
31 – 40 HP	12.8%	13.3%
41 – 50 HP	10.9%	11.8%
> 50 HP	6.1%	7.1%

About Escorts:

Headquartered in Faridabad, Haryana, Escorts Ltd. is India’s leading engineering conglomerate engaged in the manufacturing of Agri-machinery, Construction & Material Handling Equipments and Railway Equipments. Currently, the company operates in more than 40 countries and holds a market share of ~10% in the Indian market

Promoters (in %)	June 2021	Sept 2021	Dec 2021	Mar 2021	June 2022
Cumulative promoters stake	36.59	36.59	30.25	28.10	72.90

Turnaround story:

Since its inception, the group expanded into IT, Telecom and healthcare businesses which plummeted the wealth of the company and pulled them into a whole lot of debt. Nikhil (Group’s CEO) sold off these low margin and loss bearing entities to focus on making engineering products for the heavy utility and mobility industry. By the end of FY08, Escorts had INR 840 crores in debt and made INR (-37) crores in losses. More than a decade later, by the end of FY20, the business had Rs.6 crores in debt and made INR 477 crores in profits. Due to this efficient capital allocation skills Return on capital employed improved from 6% to 19% during the same time. (The same ratio for Mahindra and Mahindra today is 8.23%). 

Interestingly, the business generated INR 2,100 crores in cash over the last 10 years of which INR 650 crores was used to pay off loans, INR 200 crores was used to pay dividends and the balance of INR 1,250 crores was invested back in the business. The market cap of the business during this same time went up by INR 14,235 crores indicating a 11 times return on capital invested into the business. 

Growth factor:

A key catalyst for the growth of the company would be the Joint Venture formed with Japan’s heavy equipment leader Kubota. Escorts expanded portfolio & technology upgrades in tractors have resulted in improved numbers both in existing and new geographies. Exports have grown by 47%YoY in FY22 and expect the same trend to continue for FY23. Strategic collaboration with Kubota has led to a higher global footprint. Contract manufacturing of Escorts and Kubota products under the brand “E Kubota” is expected to commence from this quarter with an outlay of 30000 capacity. On the domestic front, a moderation in the tractor volume growth can be witnessed in H1FY23E, due to lower government subsidies owing to the unprecedented situation. However, higher export and growth in the non farm sector will drive revenue growth for the long term.

Macroeconomic factors would help the company turnaround its profits. The macro factors are turning positive with demand momentum picking up in the rural economy. The tractor industry witnessed reasonable growth over the last two years (FY20–22: +9% CAGR), which makes the base challenging. However, multiple levers such as normal monsoon forecasts, high reservoir levels and higher MSPs to reasonably support volumes in the coming quarters. It is anticipated that raw material cost headwinds might delay margin recovery in the near term; but in the long term, the company will be able to pass the RM costs to customers. 

Also to offset the inflated commodity price, the company has taken 7-8% price increase in November & in April and is also expected to do so in future. Despite subsequent price hikes it  is expected that margin might remain under pressure for the near term and expect to show some resilience in H2, owing to industry recovery and through operating leverage. 

Latest Sales Data:

On August,1, 2022, the company reported a sale of 5,360 tractors in the Agri Machinery Segment in July 2022 as against 6,564 tractors sold in July 2021. Total tractor sales during last month stood at 5,360 units as against 6,564 units in July 2021 depicting a downfall of 18.3%.

Domestic tractor sales in July 2022 were at 4,704 tractors as against 6,055 tractors sold in July 2021, down by -22.3% Export tractor sales in July 2022 were at 656 tractors as against 509 tractors sold in July 2021 registering a growth of 28.9%. Meanwhile, Escorts Kubota Limited Construction Equipment Segment reported sales of 302 machines in July 2022 as against 367 machines sold in July 2021. 

Our View:

We believe Escorts is well positioned to benefit from the improving macro factors. Overall rural sentiments are positive because of normal monsoon, high crop yield and government intention to increase agricultural productivity. While the tractor industry observed strong growth over the last two years (+9% CAGR), we also note that tractor down cycles are relatively short and less steep (last downcycle at FY15–16 where industry de-grew at 12% CAGR; FY22 decline of ~6%). We anticipate the tractor cycle to improve in FY23E, which could positively surprise broader expectations. Moreover, Kubota’s expertise is expected to accelerate market share gains and increase the addressable export markets. 

Other Brokerage:

Global research and broking firm CLSA has downgraded Escorts stock to “sell”, with a revised target price of Rs 1,612. The brokerage house said the “big miss on margin led to a negative surprise”.

The brokerage firm has cut earnings estimates by 24-26 percent over FY23-24 on a 7 percent lower volume forecast and 400 bps cut in EBITDA margin.

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