Q2FY24 Review: Escorts Kubota: Uncertainty on tractor demand continues

6 Nov 2023 , 03:24 AM

Escorts’ Q2 Ebitda missed Analysts of IIFL Capital Services estimate by 4% due to lower margins. The outlook for the tractor industry has weakened due to deficient monsoon. Mgmt. lowered FY24 industry growth guidance from ‘low-to-mid single-digit growth’ earlier to +/-2%. Mgmt. expects Escorts to do marginally better than the domestic industry but its exports have been impacted more than peers. Muted tractor growth is being compensated by growth in Construction Equipment (ECE) and Railway (RED) segments; hence, Analysts of IIFL Capital Services FY24 earnings estimates are largely unchanged despite lower tractor volumes. Escorts’ margins had fallen inexplicably in FY23 and normalised swiftly in H1FY24. As a result, earnings fell in FY23 and is seeing high growth in FY24. Now that margins have largely normalized, earnings growth would slow down in FY25. At 28x FY25 PE with 11% EPS CAGR post FY24, the stock is quite expensive. Analysts of IIFL Capital Services retain REDUCE with a TP of Rs 2,330. 

Q2 Ebitda missed estimates by 4% on lower margins: 

Escorts’ tractor volumes declined 7% YoY in Q2. Growth in non-Agri segments drove 9% YoY in revenue (2% miss). Gross margin expanded 220bps QoQ to 32.3% (est. 31.0%), led by better mix and lower input costs. Ebitda margin contracted 120bps QoQ to 12.9% vs. est. of 13.2%, due to higher operating costs. Absolute Ebitda came in 4% below Analysts of IIFL Capital Services expectations. However, PAT beat by 2% due to higher other income. 

Muted Tractor growth compensated by other segments: 

Domestic tractor industry is expected to be +/-2% in FY24 vs. FY23. Although mgmt. guided to Escorts doing marginally better than the industry in the domestic market, its overall performance will be dragged down by 20- 25% decline in exports. The other two segments, ECE and RED, have been on a strong growth trajectory, posting >50% growth in H1FY24. Additionally high-growing segments have also witnessed margin expansions due to operating leverage and commodity deflation. 

Demanding valuations at 28x FY25 EPS: 

There is uncertainty on tractor industry growth in FY24 and FY25. Escorts’ EPS growth will be lack-lustre beyond FY24, now that margin normalisation has played out. At 28x FY25 PE Analysts of IIFL Capital Services find the stock expensive. Merger with Kubota JVs may be EPS dilutive, implying that current multiples are even higher.