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Swaraj Engines (‘SWE’), a Mahindra group company, manufactures internal combustion (IC) engines for ‘Swaraj Tractors’, since its inception in the mid 1980s. SWE was a part of the erstwhile ‘Punjab Tractors Ltd’ (PTL) until the latter was acquired by Mahindra & Mahindra (M&M) in 2009. Since the acquisition by M&M, SWE has grown at a CAGR of 42% against industry growth rate of 16%. M&M acquisition has clearly been value accretive to SWE as there was a de-growth in volumes during the 3 year period prior to the acquisition – industry volumes grew @ 12% CAGR v/s 3% de-growth in SWE volumes. Leveraging on strengths of M&M (42% market share in overall tractor volumes), SWE has grown its market share from 5% earlier to 9% now. Currently, SWE is undergoing major capex, funded entirely from internal accruals, culminating in Nov 2012 with a capacity of 75000 engines per annum, against capacity of 42000 in FY11. We are positive on the long-term prospects of the company and the industry, despite an expected moderation in near-term growth on the back of high growth witnessed during last three years.
Fortunes linked to Indian agriculture
In our view, SWE is a perfect play on the India agriculture story. We are positive on the long-term prospects of Indian agriculture led by i) Gap in productivity levels in India despite having the second largest arable land in the world, resulting in need for higher farm mechanization; ii) Higher Minimum Support Prices (MSP) of farmers resulting in higher ‘income effect’; iii) Policy initiatives such as NREGA scheme, agriculture being classified as priority sector lending, subsidy on interest repayment, diesel subsidies etc.
Access to the world’s largest tractor manufacturer
SWE enjoys access to the world’s largest tractor manufacturer i.e. Mahindra & Mahindra (M&M) by virtue of the latter holding 33% in SWE. SWE caters to nearly 80% of the demand of ‘Swaraj Tractors’ division of M&M, and expects to garner 85-90% share of Swaraj Tractors. SWE believes in its own in-house technological capabilities to cope up with the upcoming challenges in terms of technology changes and believes that its technology is at par with that of global players.
Presence in high HP segment, right geographies augurs well
SWE historically has been present across segments in terms of HP i.e. 20-30HP, 31-40HP, 41-50HP and >50HP. However, going forward it believes that incremental demand for tractors are more likely in the >40HP segment. This is mainly driven by i) Increase in use of tractors for non-agri purposes such as transport, construction/ infrastructure activities etc; ii) Shift in demand from the Northern to western/ southern region where the soil is hard and requires high power tractors. Incidentally, in these regions, its parent M&M enjoys a significant market share of 44-50%; iii) replacement of tractors, where typically farmers replace older tractors with new higher HP tractors.
Positive on long-term prospects despite near-term moderation; Buy
We remain positive on the long-term prospects of the industry, despite moderation of growth rates in the near-term. Key long-term demand drivers include i) Huge demand potential for tractors in India – potential demand for 6mn tractors v/s an estimated 4mn tractors currently; ii) Low penetration levels in regions such as Bihar, South and West; iii) growing use of tractors for non-agri applications; and iv) Strong replacement demand – life of a tractor 10-15 years. We initiate coverage with Buy rating and DCF based TP of `925/share.
