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Escorts
Riding on agri growth; initiate with OUTPERFORM
We initiate coverage with OUTPERFORM and price
target of Rs181; valued at 8x one-year forward earnings,
33% discount to M&M’s core business.
We expect volume momentum and improving
realisations in tractors to result in 25% standalone
earnings CAGR over FY10-12E (Sep year end).
We expect new product launches and an improved
product mix to lead to 150bps improvement in margin for
the construction equipment subsidiary over two years.
With improved cash flows, we expect D/E to decline to
0.3x by FY12E (1.4x FY09).
Back on track – After disappointing over the past two
quarters, we believe Escorts’ core business is back on
track, driven by 1) volume momentum in tractors (we
estimate 15% volume CAGR over FY10-12E), 2) bounce
back in margins post two price hikes in the recent quarter
(we expect 160bps margin expansion by FY12E), and 3) the
auto component segment ceasing to be a drag on earnings.
In our view, standalone earnings are likely to post 25%
earnings CAGR over FY10-12E.
Construction equip. subsidiary to support earnings –
The robust outlook for the construction equipment sector
(likely to post 15% CAGR over the next four years) coupled
with a much improved product mix (launch of the highly
successful, high-margin backhoe loader and plans to launch
higher tonnage cranes) is likely to revive ECEL’s earnings
(ECEL contributes 5% of consolidated EBIT) over FY10-12E
(we factor in 150bps margin improvement over the period).
Debt declines, BS restructuring complete – Escorts has
reduced its D/E to 0.7x (1.4x in FY09). We expect it to
decline further given strong cash flows over FY10-12E.
Escorts has cleaned up its balance sheet, exited unrelated
businesses and is now focusing on its core divisions.
Valuation – We value Escorts as a pure tractor play (89%
contribution to profit in FY12E) with the nearest comparable
proxy being M&M. Given M&M’s leadership, earnings profile
and scale, we value Escorts at a 33% discount to M&M’s
core business multiple (12x) at 8x – which is also its historic
average forward multiple. We believe margin revival would
be a key catalyst for the stock over the next 3-6 months.
Risks – Rising cost of raw materials, lower-than-expected
rainfall, diversification into un-related businesses
Investment argument and valuation
After disappointing over the past two quarters, we expect Escorts’ core business to bounce
back driven by sustained volume momentum and improved realisations in the agri segment.
Strong outlook for construction equipment coupled with a much improved product mix is likely
to boost ECEL’s earnings over FY10-12E (estimated 150bps margin increase over two years).
Escorts has cleaned up its balance sheet, sold loss making and unrelated business segments
and is now focusing on the core business.
With improved cash flows, debt is also on a declining trend.
At 6x FY12E earnings and 2.8x FY12E EV/EBITDA, valuations are attractive. Initiate with
OUTPERFORM with price target of Rs181; valued at 8x one-year forward earnings; 33%
discount to M&M’s core business multiple.
Turnaround on track
Over the past few years, Escorts has been in restructuring mode. It has exited unrelated
businesses, cleaned up its balance sheet and re-structured the management team. All with the
single-minded aim to focus on core business segments: agri (75% of revenue, 87% of EBIT),
construction equipment – through 100%-owned Escorts Construction Equipment – (17% of
revenue, 5% of EBIT) and engineering (8% of revenue, 8% of EBIT). This concerted effort turned
around its operations – in two years, operating margin increased 220bps to 7.1% in FY10.
Nevertheless, the past two quarters have been disappointing, leading to a sharp de-rating of the
stock (stock price slumped 59% in three months from an all-time high of Rs246 to Rs100 in
Feb ’11).
What went wrong in the last two quarters?
Following strong operational performances over six quarters to 3Q FY10, Escorts’ operating
margin fell a sharp 480bps qoq in 4Q FY10 to 4.9% and failed to recover even in 1Q FY11
(5.6%). The key reasons:
1. In 4Q FY10 (year end Sep), the company took a one-time hit of Rs100m as directors’
remuneration is linked to full-year profits. While this is normal practice for the company, the
lack of disclosure by management led to a significant earnings disappointment in the quarter.
Impact: The stock witnessed significant selling pressure and declined 37% after the results
announcement.
2. In 1Q FY11, the company had planned to raise prices in conjunction with the launch of key
variants in Nov ’10. But it never happened as the launches were delayed due to technical
issues. The result: a sharp cost push in 1Q FY11, which the company absorbed but which
hurt agri segment profitability (margins declined 140bps yoy). To add to its woes, the railway
equipment segment did not get any new orders from the Indian Railways. This coupled with
rising competition in the segment squeezed margins from its most profitable entity (from an
average of 20% in FY09, this segment’s margin declined to 7% by 1Q). Furthermore, the
auto-component segment turnaround also took longer than expected. All these factors led to
the disappointing operational performance for the second consecutive quarter.
Impact: The stock crashed by a further 24% post results and fell to a low of Rs100 in Feb ’11.
Why are we positive now?
Agri business: New launches, price hikes to improve performance
1. We expect the domestic tractor industry to maintain its strong growth momentum and post
15% two-year volume CAGR over FY10-12E. The main drivers: 1) high rural liquidity given
higher minimum support prices for crops, 2) government focus on the farm sector (larger
budgetary allocations, priority sector lending, interest subventions, etc), 3) huge labor
shortages due to alternative earnings sources like NREGA schemes, 4) reduced
dependence on lending (financing has come off from 90% to about 65% recently), and 5)
increased non-agricultural usage. We believe Escorts will be a main beneficiary of robust
industry growth given that it is the third-largest player in the industry.
Given below are some of Escorts’ key initiatives to boost sales.
Fig 1 – Key initiatives to tap rising opportunities in the sector
New model launches
Launched 5 tractors in FY10, launched the first of its kind inverter
tractor in India which saw an encouraging response; launched the JaiKisaan range of tractors in North India in Feb ’11; planning to launch it
in Central India in a couple of months
Improving presence in South India
(current market share a meager 4%)
Established a new office with a dedicated sales team, likely to launch
region-specific tractors for application for wet land application (paddy
crop), increasing dealer / customer touch points in the region
Tapping export opportunity
The company plans to focus on the African and South-east Asian
markets to increase its export presence
Source: Company, Standard Chartered Research
2. Escorts has raised prices twice, the first in Feb ’11 (~Rs2,500 per unit) and the second in
Mar ’11 (~Rs12,500). Given that competition has also hiked prices by a similar amount, we
do not expect any market share loss. These price hikes, we believe, are sufficient to cover
higher input costs and to help the agri division retain its normal margin of 9-10% (likely to be
achieved only in 3Q FY11 as the full impact of the price hikes is felt). We have factored in a
conservative 8.5% margin for 3Q FY11.
3. Our estimates factor in 21% revenue CAGR for the agri-business, led by 15% volume CAGR
over the same period. We also factor in 160bps margin improvement in this division from
current levels to 8.4% by FY12E led by sustained volume off take at better realizations.
Auto-ancillary division: break-even round the corner
Management aims to achieve break-even by 4Q FY11 through a two-pronged strategy: 1)
Completely realign production facilities and sales and marketing efforts and focus on
manufacturing higher-margin 4W components such as shock absorbers, struts, etc (earlier 90%
of the product mix was 2W components). Through its initiatives, Escorts has already won new
orders for 4W components from a leading OEM in the US as well as from Tata Motors’ Ace
platform in the domestic market. The company is now in discussions with other OEMs like M&M,
Suzuki to supply components. 2) Escorts has set up a trading business whereby the company will
buy auto components from low-cost countries like China, re-brand them and sell them in the
domestic market. The trading business is also likely to achieve healthy margins. These
components are likely to drive revenue growth for the ancillary business. We expect the auto
ancillary business to break-even by FY12E
Railway equipment division: Investing for a secure future
While the order flow from the Indian Railways continued to be lackluster, Escorts is going ahead
and investing in technology tie-ups with leading global majors to upgrade its products. Thus,
while the railway division’s performance is likely to be muted over the next 12-15 months, we
believe Escorts would be well-placed to take orders once the Indian Railways rolling stock upgrade program kicks off.
Attractive valuations; Initiate with OUTPERFORM
We value Escorts as a pure tractor play primarily on account of the following two reasons:
1. Even by FY12E, almost 89% of segmental earnings are likely to come from the agrimachinery division.
2. The construction equipment division is in a ramp-up phase with its own set of risks (product
failures, significant competition, etc). Hence, we refrain from valuing this business separately.
We would start valuing this business separately only once it makes a meaningful
contribution to consolidated earnings.
Key risks
Deficient monsoons may hamper agricultural output, hence tractor sales
Lower-than-normal rainfall may lead to lower crop output which may indirectly impact tractor offtake going forward. Lower-than-expected tractor sales is a key risk to our estimates.
Input cost pressure
While the company has passed on the rising cost pressure in this quarter, it may not be able to
do so in case of a sustained and relentless cost rise, which is a key risk to our estimates.
Rising competition, product failures may hinder ECEL’s earnings
While Escorts is trying to establish its presence in the backhoe loaders segment and higher
tonnage cranes, etc, by launching new products, any failures in new product launches or
postponement of these launches may impact our estimates. Also, margin impact due to
significant competitive pressure may impact our estimates.
Diversification into unrelated business segments
Escorts’ promoters had in the past ventured into too many unrelated business segments, which
led to the company eventually loosing focus. While management has indicated that it is clearly
focused on its core business segments (agriculture, engineering and construction equipment),
any unrelated diversification may hurt investor sentiment and loss of confidence in management.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Escorts
Riding on agri growth; initiate with OUTPERFORM
We initiate coverage with OUTPERFORM and price
target of Rs181; valued at 8x one-year forward earnings,
33% discount to M&M’s core business.
We expect volume momentum and improving
realisations in tractors to result in 25% standalone
earnings CAGR over FY10-12E (Sep year end).
We expect new product launches and an improved
product mix to lead to 150bps improvement in margin for
the construction equipment subsidiary over two years.
With improved cash flows, we expect D/E to decline to
0.3x by FY12E (1.4x FY09).
Back on track – After disappointing over the past two
quarters, we believe Escorts’ core business is back on
track, driven by 1) volume momentum in tractors (we
estimate 15% volume CAGR over FY10-12E), 2) bounce
back in margins post two price hikes in the recent quarter
(we expect 160bps margin expansion by FY12E), and 3) the
auto component segment ceasing to be a drag on earnings.
In our view, standalone earnings are likely to post 25%
earnings CAGR over FY10-12E.
Construction equip. subsidiary to support earnings –
The robust outlook for the construction equipment sector
(likely to post 15% CAGR over the next four years) coupled
with a much improved product mix (launch of the highly
successful, high-margin backhoe loader and plans to launch
higher tonnage cranes) is likely to revive ECEL’s earnings
(ECEL contributes 5% of consolidated EBIT) over FY10-12E
(we factor in 150bps margin improvement over the period).
Debt declines, BS restructuring complete – Escorts has
reduced its D/E to 0.7x (1.4x in FY09). We expect it to
decline further given strong cash flows over FY10-12E.
Escorts has cleaned up its balance sheet, exited unrelated
businesses and is now focusing on its core divisions.
Valuation – We value Escorts as a pure tractor play (89%
contribution to profit in FY12E) with the nearest comparable
proxy being M&M. Given M&M’s leadership, earnings profile
and scale, we value Escorts at a 33% discount to M&M’s
core business multiple (12x) at 8x – which is also its historic
average forward multiple. We believe margin revival would
be a key catalyst for the stock over the next 3-6 months.
Risks – Rising cost of raw materials, lower-than-expected
rainfall, diversification into un-related businesses
Investment argument and valuation
After disappointing over the past two quarters, we expect Escorts’ core business to bounce
back driven by sustained volume momentum and improved realisations in the agri segment.
Strong outlook for construction equipment coupled with a much improved product mix is likely
to boost ECEL’s earnings over FY10-12E (estimated 150bps margin increase over two years).
Escorts has cleaned up its balance sheet, sold loss making and unrelated business segments
and is now focusing on the core business.
With improved cash flows, debt is also on a declining trend.
At 6x FY12E earnings and 2.8x FY12E EV/EBITDA, valuations are attractive. Initiate with
OUTPERFORM with price target of Rs181; valued at 8x one-year forward earnings; 33%
discount to M&M’s core business multiple.
Turnaround on track
Over the past few years, Escorts has been in restructuring mode. It has exited unrelated
businesses, cleaned up its balance sheet and re-structured the management team. All with the
single-minded aim to focus on core business segments: agri (75% of revenue, 87% of EBIT),
construction equipment – through 100%-owned Escorts Construction Equipment – (17% of
revenue, 5% of EBIT) and engineering (8% of revenue, 8% of EBIT). This concerted effort turned
around its operations – in two years, operating margin increased 220bps to 7.1% in FY10.
Nevertheless, the past two quarters have been disappointing, leading to a sharp de-rating of the
stock (stock price slumped 59% in three months from an all-time high of Rs246 to Rs100 in
Feb ’11).
What went wrong in the last two quarters?
Following strong operational performances over six quarters to 3Q FY10, Escorts’ operating
margin fell a sharp 480bps qoq in 4Q FY10 to 4.9% and failed to recover even in 1Q FY11
(5.6%). The key reasons:
1. In 4Q FY10 (year end Sep), the company took a one-time hit of Rs100m as directors’
remuneration is linked to full-year profits. While this is normal practice for the company, the
lack of disclosure by management led to a significant earnings disappointment in the quarter.
Impact: The stock witnessed significant selling pressure and declined 37% after the results
announcement.
2. In 1Q FY11, the company had planned to raise prices in conjunction with the launch of key
variants in Nov ’10. But it never happened as the launches were delayed due to technical
issues. The result: a sharp cost push in 1Q FY11, which the company absorbed but which
hurt agri segment profitability (margins declined 140bps yoy). To add to its woes, the railway
equipment segment did not get any new orders from the Indian Railways. This coupled with
rising competition in the segment squeezed margins from its most profitable entity (from an
average of 20% in FY09, this segment’s margin declined to 7% by 1Q). Furthermore, the
auto-component segment turnaround also took longer than expected. All these factors led to
the disappointing operational performance for the second consecutive quarter.
Impact: The stock crashed by a further 24% post results and fell to a low of Rs100 in Feb ’11.
Why are we positive now?
Agri business: New launches, price hikes to improve performance
1. We expect the domestic tractor industry to maintain its strong growth momentum and post
15% two-year volume CAGR over FY10-12E. The main drivers: 1) high rural liquidity given
higher minimum support prices for crops, 2) government focus on the farm sector (larger
budgetary allocations, priority sector lending, interest subventions, etc), 3) huge labor
shortages due to alternative earnings sources like NREGA schemes, 4) reduced
dependence on lending (financing has come off from 90% to about 65% recently), and 5)
increased non-agricultural usage. We believe Escorts will be a main beneficiary of robust
industry growth given that it is the third-largest player in the industry.
Given below are some of Escorts’ key initiatives to boost sales.
Fig 1 – Key initiatives to tap rising opportunities in the sector
New model launches
Launched 5 tractors in FY10, launched the first of its kind inverter
tractor in India which saw an encouraging response; launched the JaiKisaan range of tractors in North India in Feb ’11; planning to launch it
in Central India in a couple of months
Improving presence in South India
(current market share a meager 4%)
Established a new office with a dedicated sales team, likely to launch
region-specific tractors for application for wet land application (paddy
crop), increasing dealer / customer touch points in the region
Tapping export opportunity
The company plans to focus on the African and South-east Asian
markets to increase its export presence
Source: Company, Standard Chartered Research
2. Escorts has raised prices twice, the first in Feb ’11 (~Rs2,500 per unit) and the second in
Mar ’11 (~Rs12,500). Given that competition has also hiked prices by a similar amount, we
do not expect any market share loss. These price hikes, we believe, are sufficient to cover
higher input costs and to help the agri division retain its normal margin of 9-10% (likely to be
achieved only in 3Q FY11 as the full impact of the price hikes is felt). We have factored in a
conservative 8.5% margin for 3Q FY11.
3. Our estimates factor in 21% revenue CAGR for the agri-business, led by 15% volume CAGR
over the same period. We also factor in 160bps margin improvement in this division from
current levels to 8.4% by FY12E led by sustained volume off take at better realizations.
Auto-ancillary division: break-even round the corner
Management aims to achieve break-even by 4Q FY11 through a two-pronged strategy: 1)
Completely realign production facilities and sales and marketing efforts and focus on
manufacturing higher-margin 4W components such as shock absorbers, struts, etc (earlier 90%
of the product mix was 2W components). Through its initiatives, Escorts has already won new
orders for 4W components from a leading OEM in the US as well as from Tata Motors’ Ace
platform in the domestic market. The company is now in discussions with other OEMs like M&M,
Suzuki to supply components. 2) Escorts has set up a trading business whereby the company will
buy auto components from low-cost countries like China, re-brand them and sell them in the
domestic market. The trading business is also likely to achieve healthy margins. These
components are likely to drive revenue growth for the ancillary business. We expect the auto
ancillary business to break-even by FY12E
Railway equipment division: Investing for a secure future
While the order flow from the Indian Railways continued to be lackluster, Escorts is going ahead
and investing in technology tie-ups with leading global majors to upgrade its products. Thus,
while the railway division’s performance is likely to be muted over the next 12-15 months, we
believe Escorts would be well-placed to take orders once the Indian Railways rolling stock upgrade program kicks off.
Attractive valuations; Initiate with OUTPERFORM
We value Escorts as a pure tractor play primarily on account of the following two reasons:
1. Even by FY12E, almost 89% of segmental earnings are likely to come from the agrimachinery division.
2. The construction equipment division is in a ramp-up phase with its own set of risks (product
failures, significant competition, etc). Hence, we refrain from valuing this business separately.
We would start valuing this business separately only once it makes a meaningful
contribution to consolidated earnings.
Key risks
Deficient monsoons may hamper agricultural output, hence tractor sales
Lower-than-normal rainfall may lead to lower crop output which may indirectly impact tractor offtake going forward. Lower-than-expected tractor sales is a key risk to our estimates.
Input cost pressure
While the company has passed on the rising cost pressure in this quarter, it may not be able to
do so in case of a sustained and relentless cost rise, which is a key risk to our estimates.
Rising competition, product failures may hinder ECEL’s earnings
While Escorts is trying to establish its presence in the backhoe loaders segment and higher
tonnage cranes, etc, by launching new products, any failures in new product launches or
postponement of these launches may impact our estimates. Also, margin impact due to
significant competitive pressure may impact our estimates.
Diversification into unrelated business segments
Escorts’ promoters had in the past ventured into too many unrelated business segments, which
led to the company eventually loosing focus. While management has indicated that it is clearly
focused on its core business segments (agriculture, engineering and construction equipment),
any unrelated diversification may hurt investor sentiment and loss of confidence in management.
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