Escorts - Reaching for low-hanging fruits! - Antique

Recent growth on low base

In 3QFY12 (Sep year-end), revenues were up 17% YoY (8% QoQ), on the back of an 18% YoY (10% QoQ) growth in tractor segment revenues (~90% of segment revenues).

Despite a tough quarter for the tractor industry (M&M's tractor volumes fell 1% YoY, industry volumes up 2.3% YoY), Escorts' tractor volumes were up 14% YoY; 8% QoQ primarily on the back of a low base (last year same quarter, their tractor volumes had fallen 21% YoY).

Tractor margins improve; Auto Anc division finally breaks even

EBITDA margins stood at 6.5% (up 221bps YoY; 97bps QoQ) aided by an expansion in tractor division EBIT margins (at 8.6% - up 267bps YoY; 90bps QoQ). Furthermore, the auto ancillary division finally broke-even with an EBIT loss of just INR0.4m for the quarter (vs. an EBIT loss of INR48.8m YoY; INR28.7m QoQ).

Railway division disappointed with an EBIT margin of 2.1% (down 829bps YoY; 426bps QoQ), but margins for this division are normally quite erratic on a quarterly basis. Based on this improvement in tractor margins and break-even in the Auto Anc division, PAT at INR269m (up 103% YoY; 48% QoQ), beat our estimate of INR150m (consensus 184m).

Multiple margin levers ahead... But it might test your patience!

For most segments (tractors/auto ancs and construction equipment), there are some low-hanging fruits in terms of further margin improvement. Escorts' tractor margins at ~8% remain a staggering ~800bps lower than those of M&M's and hence there is enough headroom for catch-up once utilisation levels increase.

Also, the construction equipment division has historically been a 7-8% margin business and scale up to that level remains an additional margin kicker. Hence, multiple margin levers remain. However, we must warn that we have been waiting for these levers to pan out for several quarters now and have continuously been disappointed.

HOLD on wishful thinking...

With headwinds in the tractor industry coupled with Escorts' relatively higher vulnerability to competitive pressures, we remain cautious on the stock.

Valuations have always been cheap {currently at an FY13 (Sep year-ending) P/E of 5.3x, EV/EBITDA of 3.0x, EV/Sales of 0.1x}, as they reflect of the poor return ratios (5-7%) and even poorer track record. Maintain HOLD on some wishful think and a presumption that earnings can't get much worse from here.

Source : Equity Bulls

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