Escorts - Value Pick:: Anand Rathi

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Closing 76                              BUY                      Target 140

 Investment Rationale 

~ Business performance – agri mechanization -pioneer

~ Reversal in product-mix towards high-HP tractors

~ Looking ahead with new strategies

~ Technical collaboration to expand business focus

~ Capex plans

~ Industry demand

Outlook & Valuations

Looking at the company and the industry, there are clear concerns. Being an agri-mechanism pioneer and with its efforts to expand would work in its favour. Also, Escorts is low on debt, and has ~Rs.3,191 million in cash on hand. With capacity utilization at lower levels (~62% FY1009) there is huge scope for improved utilization levels and cope up with the increasing demand going forward. Also Escorts is regaining its markets share from its new strategies, also the construction equipment business and the railway equipment business will register good growth after improved economic outlook and huge spending by the government as well.

At the CMP, the stock trades at 5.7x FY12 and 4.3x FY13 estimated earnings (The company has a September year-end). We see a price of Rs.140 within two years . 

• Reversed product mix, towards high-HP tractors

Escorts’ share of over-40 horsepower tractors in industry sales

has been steadily increasing since 2003-04; it was 38% in 2009-

10 (from 25% in 2002-03). This was due to the rising use of

higher-horsepower tractors in the north and the increasing share

in southern and western states, where higher-horsepower tractors

are preferred, given the harder soil. In addition, the rising share of

exports, where >40-hp tractors dominate (more than 75% in 2009-

10), has contributed to an increasing offtake of higher-horsepower

tractors.

• Looking ahead with new strategies

Escorts is taking several steps to neutralize the impact of higher

input costs. This includes changing the product mix towards midand

higher-horsepower tractors (50-HP and above), and an

increasing presence in western and southern markets. Tractor

volumes have been improving constantly. The company has lined

up various launches of products, specially in the southern

markets.

Ahead, its aggressive market strategies, product launches, recent

price revisions and the ongoing cost-compression exercise should

provide some cushion against continuing inflationary pressures.

The company is also planning to venture into the African market.

• Technical collaborations to expand business focus

Dako, CZ: Escorts has tied up with Dako to develop disc-brake

systems. The prototype sets are expected to be fitted on two LHB

(Linke Holfmann Bush) high-speed coaches this year. The Indian

Railways now builds 600 LHB coaches, and plans to ramp that up

to 4,000 coaches per year by 2016.

Ingeteam, Spain: Escorts has tied up with Ingeteam of Spain to

develop traction systems for DEMU (Diesel Electric Multiple unit)

trains. The development time for this is 12-18 months on the

award of a development order. The Indian Railways builds about

400 DEMU coaches annually. These collaborations will help

expand the business in the railway-equipment segment.

• Capex plans

Escorts has planned capex of Rs.1,400 million to Rs.1,600 million

to be spent over the next two years. A major portion of this

expansion is related to investment in R&D, adding more

machines, de-bottlenecking of present capacity and making the

present capacity more flexible.

The company also holds ~Rs. 10713.3mn of worth land which if it

plans to monetize then that will add to the cash for the company.

Since its also low on debt this cash can be further used for any

capex plans going forward without any raising of debt.

• Industry Demand

Agriculture is the backbone of the Indian economy. There is vast

potential for farm mechanization, in which Escorts is a pioneer.

Changing demographics adds to demand for farm mechanization.

The rise in MSP has boosted the earnings of the farmers and has

eventually led to higher demand for tractors in India.

Government supportive schemes like NREGA Scheme - leading

towards mechanization. This has led to shortage of farm labourers

which has also resulted in increase in cost of labour. This has

resulted in gradual increase in usage of tractors in turn.

Infrastructure growth, led by government spending plans, leads to

potential for the construction equipment sector. Though this sector

will throw up concerns, it will be lead in boosting the economy.

The new projects, aimed at railway upgrading and expansion, are

on the cards, which would benefit Escorts.

The auto-component segment is also faced with concerns looking

at the present economic condition. But with the fast-emerging

global auto hub in India, it will grow in coming years.

Concerns

Great dependence on the monsoons and on government policies.

Any increase in raw material (steel and tyres) would put pressure

on financial performance.

Outlook & Valuations

Looking at the company and the industry, there are clear

concerns. Being an agri-mechanism pioneer and with its efforts to

expand would work in its favour. Also, Escorts is low on debt, and

has ~Rs.3,191 million in cash on hand. With capacity utilization at

lower levels (~62% FY1009) there is huge scope for improved

utilization levels and cope up with the increasing demand going

forward. Also Escorts is regaining its markets share from its new

strategies, also the construction equipment business and the

railway equipment business will register good growth after

improved economic outlook and huge spending by the

government as well.

At the CMP, the stock trades at 5.7x FY12 and 4.3x FY13

estimated earnings (The company has a September year-end).

We see a price of Rs.140 within two years.