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MOSL : ESCORTS: Disappointing result with loss of market share & margins

ESCORTS: Disappointing result with loss of market share & margins

(ESC IN, Mkt Cap USD2.9b, CMP INR1722, TP INR1575, 9% Downside, Neutral)

Expects industry to grow in low-mid single digit in FY23

• ESCORTS' 1QFY23 performance was severely impacted by weaker mix and a sharp increase in steel prices. It lost market share of ~140bp YoY as the company focused on balancing market share and margins. While 2HFY23 outlook is still unclear, visibility on margins recovery is high though market share revival needs to be monitored carefully.
• We cut our FY23E/FY24E EPS by 7%/6% to factor in deteriorating mix and lower volumes thus affecting the margins. Maintain Neutral with a TP of INR1,575 (premised on 18x Sep'24E consolidated EPS).

 

Operating deleverage combined with high RM costs hit margins

• ESCORTS' revenue grew 20.5% YoY to INR20.15b but EBITDA/PAT declined 14%/20% YoY to ~INR2b/INR1.47b, respectively, in 1QFY23.
• Tractor volumes grew 3% YoY. Net realizations improved 9% YoY to INR595.5k (est. INR635k) led by the weaker mix. Tractor/construction equipment/railways revenues grew 13%/75%/ 45% YoY, respectively.
• Gross margin contracted 4pp YoY (2.1pp QoQ) to 27.8% (v/s est.28.6%) due to weaker mix (increase in lower HP sales) and higher RM cost. Consequently, EBITDA margin declined 4pp YoY to 10% (v/s est. 12.1%).
• PBIT margin for tractors dropped 5pp YoY/4.8pp QoQ to 10.6%, while PBIT margin for railways was at 13.6% (-1pp YoY/-40bp QoQ) and CE was at 1% (v/s -2.3% in 1QFY22).
• PAT declined 20% YoY to INR1.47b (v/s est. INR1.87b).

Highlights from the management commentary

• Tractor industry outlook: Management expects domestic industry to grow at low- to mid-single digit, with 2QFY23 to rise in mid-single digit despite likely decline in Jul-Aug'22, as Sep'22 is expected to see strong growth due to early onset of festive season. Considering very good reservoir levels across the country, any weakness in monsoon may not affect farm segment this year but may hurt next year.
• There is a reversal in trend of upshift to higher HP tractor, as 1QFY23 saw the mix movement in favor of lower HP segment.
• ESCORTS lost market share of 140bp YoY (-210bp QoQ) to 9.3%, as it decided to balance out market share and profitability and not compete on pricing. Management is taking initiatives to recover market share in a few months, as it knows markets (its strong markets) and segments where it needs to bounce back.
• Management expects margins to start improving from 2QFY23 onwards led by price hike of 2% taken so far along with softening in commodity prices.
• Railways business order book has nearly doubled QoQ to INR8.5b (from INR4.4b as of Mar'22). The company expects double-digit growth in FY23 revenue.

Valuation and view

• Uncertainty in the Tractor cycle would result in muted earnings growth over the next few quarters, especially considering the high base for the next two quarters. Faster recovery in other businesses and a ramp-up in its partnership with Kubota would offset the adverse impact of a weaker Tractor cycle.
• The stock trades at 21.3x consolidated FY24E EPS, at a premium to its 10-year average of 12x, driven by an improvement in operating parameters as well as the Kubota partnership. While tractor cycle seems to be near trough, the valuations are already reflecting the likely recovery in FY24. Maintain Neutral with a TP of INR1,575 (premised on 18x Sep’24E consolidated EPS).