• Net sales increase 12.9% yoy driven by 12.7% yoy rise in volumes while realizations were flat with 0.2% rise, sequentially revenues were higher by 4.2% led by 4% qoq rise in volumes and 0.2% qoq rise in realizations

• OPM at 15.0% was in line with our expectations of, OPM was higher by lower by 10bps sequentially while remained flat on yoy basis

• PAT was at Rs176mn was lower than estimates and was higher by 4.5% yoy but remained flat on qoq basis

• Growth in volumes was on account of robust increase in tractor volumes of M&M and particularly Swaraj brand tractors  

• We assign a BUY rating as tractor volumes in the continue are expected to remain strong given strong rural consumer sentiment and government’s impetus on agricultural growth

Net sales growth of 12.9% yoy, in line with expectations

Swaraj Engines during Q1 FY15 reported revenues of Rs1.7bn which represented a growth of 12.9% yoy and 4.2% qoq. Volumes and revenue were in line with our expectations. The growth in revenues was on the back of 12.7% yoy increase in volumes while realizations were muted with 0.2% yoy growth. On a sequential basis, volumes were higher by 4% while realizations rose 0.2%. Growth in volumes was on the back of strong growth in tractor volumes for Swaraj Engines parent company M&M. During Q1 FY15, while M&M reported flat volumes, mix was predominantly towards Swaraj brand tractors. Volumes at 20,044 units for Q1 FY15 represent 107% utilization on annual capacity of 75,000 units.

OPM in line with expectations, flat yoy but falls 10bps sequentially

During Q1 FY15, OPM for Swaraj Engines came in at 15.0% in line with our expectations. While operating profit was higher by 12.7% yoy it rose 3.6% qoq. OPM was flat on yoy basis while it declined by 10bps sequentially. On a yoy basis while gross margins expanded by 34bps, 41bps yoy increase in staff costs as a percentage of net sales led to an offsetting impact. Sequentially, gross margins were lower by 42bps, which was partially offset by 19bps and 13bps qoq decline in staff costs and other overheads respectively.

Higher depreciation restricts PAT growth

The company reported a PAT of Rs176bn which was lower than our expectations of Rs184mn. PAT growth was at 4.5% yoy as compared to operating profit growth of 12.7%. The underperformance was owing to higher depreciation as the increased capacity came into operations during the year. Also depreciation was higher in the quarter by Rs8mn as the company reworked depreciation in accordance with the provisions of the Companies Act 2013. Other income was also lower by 9.6% yoy.

With continued increase in MSPs, expected recovery in infrastructure spend and government’s impetus on agricultural growth we expect tractor volumes to continue on a strong footing. To meet the possible increase in demand Swaraj Engines is expanding its capacity from 75,000 currently to 105,000 units over the next 12-18 months. We expect 21% revenue CAGR over FY14-16E and 60bps expansion in margins will entail 24% earnings CAGR. With zero debt balance sheet, RoE of 30%+ and strong free cash flow generation, we find P/E valuations of 10.9x on FY16E EPS of Rs83.3 attractive. The company will continue to see strong dividend payouts given the expected robust cash flow generation. We recommend BUY with a revised target price of Rs1,082.