Auto Sector: Tractors Eying new highs ::Emkay

Please Share:: India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��

Auto Sector: Tractors

Eying new highs

There have been rising concerns on the sustainability of tractor demand owing to certain adverse developments and the strong performance of the tractor segment over the last few years (17% CAGR during FY08-11 and 20% YTDFY12).

Recent adverse developments like (1) declining Agri terms of trade (ATOT) (2) lack of buying support by FCI, resulting in produce being sold below MSPs and (3) slowdown in agri credit/rising NPAs (of PSU banks), have raised concerns over cash flows of the farmers

Some of these concerns are overdone, while others are still nascent. If these concerns materialize, then there can be pressure on tractor demand in the short term. However, this would be a temporary blip as structurally, demand continues to be on an upswing and it is nowhere near its peak. Our confidence stems from a number of indicators highlighted below

n     Indian tractor industry is more stable than Cars/M&HCVs. Since 1973, the tractor industry has registered a CAGR of 8.6%.

n     While India’s tractor penetration at 19 per 1000 hectares appears reasonable, we believe it is misleading. Penetration per 1000 agricultural people is a better indicator. At 5 per 1000, India’s tractor penetration is among the lowest.

n     Across the globe, there has been a sharp reduction in population relying on agriculture as a source of income. This is evident from the fact that current penetration levels (per 1000 hectares) are significantly below their peak levels.  India is the only country, where there has been an increase in population relying on agriculture, thereby supporting tractor demand

n     Increasing focus of government has resulted in higher penetration of finance amongst the target customers. Interestingly, there is no correlation between agri lending and tractor demand. We found a much higher correlation between NABARD disbursements and tractor demand

n     Favorable cost dynamics and lack of restriction on use of tractors for other purposes have triggered additional demand for tractors. Non farm usage of tractors is on the rise and constitutes ~40% currently.

n     Shortening replacement age of tractors further supports short term demand. The replacement age has reduced from ~12 years to ~8 years. In case of extensive use of tractors for non farm purposes, the replacement age stands further reduced to 5 years

n     Rising multiplier effect, indicating higher demand for tractors vs. the earlier periods

n     Shortage of labor is a serious problem, which has acted as a key catalyst for tractor demand

The above factors make us believe that the industry can register a strong growth of 12.5% CAGR over FY11-14E, with an upward bias (implying 12%/10% growth in FY13E/FY14E). Even if the above mentioned concerns play out, we believe that 8% growth is possible in FY13.

The key beneficiary of the structural demand in tractors will be M&M, given its balanced regional and product mix as well as the ability to understand and adapt to the market dynamics. We have a BUY on the stock with a TP of Rs 920 per share. We find valuations attractive as they are pricing in a sharp drop in EBIDTA/margins in FY13.