Q1FY24 Review: Escorts Kubota: Sharp margin normalisation priced in

3 Aug 2023 , 02:16 PM

Escorts reported a very strong Q1FY24 (30% Ebitda beat), driven primarily by sharp normalisation in margins from the lows of Q3FY23. While Tractor growth was muted in the quarter, non-tractor segments (Construction Equipment, Railway) did very well on growth. Margin performance was strong across segments. Mgmt attributed the margin spike to price hikes and lower input costs and exuded confidence of it sustaining at these levels. As a result of the faster than expected margin normalisation, analysts of IIFL Capital Services have upgraded FY24/FY25 EPS by 15%/10%. Analysts of IIFL Capital Services retain REDUCE as they find the stock expensive at 24x FY25 (even higher, if they account for EPS dilution due to merger with 2 JVs). FY25 already builds in 5 years of upcycle in tractors as well as full margin normalisation (margin gap vs Mahindra tractors now at historical low). 

Q1 results much better than expected: 

Q1 revenue grew 16% YoY and beat analysts of IIFL Capital Services estimate by 4% (higher Railway segment rev.). Gross margin (GM) expanded 170bps QoQ to 30.2% (est. 28.5%), led by price hikes and lower input costs. Ebitda margin improved 320bps QoQ to 14.0% vs. est. of 11.3% (GM expansion + lower operating exp.). Absolute Ebitda came in 30% above their expectations. PAT beat was 31%. 

Sudden normalisation in margin after inexplicable fall in previous quarters: 

Escorts’ Tractor Ebit margin had fallen inexplicably by 700bps from 15.4% in Q4FY22 to 8.4% in Q2FY23. M&M’s margin was almost flat during this period. And now, in a span of 2 quarters, Tractor margin has bounced back by 500bps to 13.4%. Management attributed the swing to movement in commodity prices and lag in pricing. However, the difference in margin performance of the two OEMs is quite surprising. Post the sharp normalisation, analysts of IIFL Capital Services expect margins to stabilise around these levels. 

Stock expensive at 24x FY25 EPS: 

The tractor industry had a strong upcycle over FY21-FY23 (FY23 volume 33% above FY20). After 3 strong years, the probability of high growth in coming years is quite low. The margin normalisation angle has also played out, with the gap between Escorts and M&M Tractor margins having narrowed to historical lows. At current price, the stock is trading at 24x on FY25 EPS, which already builds in 5 years of tractor upcycle and full normalisation of margins. If analysts of IIFL Capital Services account for the EPS dilutive impact of the impending merger with 2 Kubota JVs, the stock is even more expensive.