Escorts - At an inflexion point!! - Nirmal Bang

Escorts has seen management changes in the past one year. Management has prepared a road map for the company where it outlined various initiatives which would ultimately lead to improvement in the EBITDA margins of the company 3x from the levels of ~5%. Management has also shifted focus towards the higher margin yielding higher HP segment which now contributes more than 50% of sales. The change in product mix, determination to target higher levels of profitability by focusing on cost discipline (manpower and raw material cost) has started yielding results in the form of improvement in the company's performance from the last 2-3 quarters. We believe that Escorts is currently at an inflexion point from where improvement signs is visible and in our view will continue.

Tractor industry has also seen a revival with good monsoon and the outlook for the tractor industry remains favorable. With elections round the corner, the government's focus on farm mechanization will spur demand for tractors. Agri equipment contributes to nearly 83% of sales of the company. Moreover, with some improvement in the economic conditions, the company's construction equipment business (9% of sales) will also witness improvement.

Q4 (quarter ending September) is a seasonally weak quarter for the industry as a whole; however October and November are expected to be good season for the company considering the festive season. Escorts Ltd reported good results for Q3FY13 (September ending), which were above street expectations.

- Revenues increased 17.5% QoQ and 16% YoY. Realizations improved due to the price hikes in February and May 2013 and higher sales of premium products enabled significant jump in margins.

- EBITDA margins improved to 7.9%, the highest in the last 12 quarters. Margins stood at 5.3% in Q3FY12 (June 2012). Escorts follows September year end.

- However, construction equipment and auto ancillary segment continued to witness pressure in line with industry trend.

- Railways witnessed a remarkable improvement and margins stood at 10.1% vs 2.1% in Q3FY12 and 7.6% in Q2FY13.

- Tax rate normalized to 19.1% this quarter after a tax credit of Rs6.2 cr taken in the previous quarter. Management expects tax rate to be in the range of 20-22% for FY14E.

We expect Escorts to witness a CAGR growth of 24.6% in EBITDA and 51.4% in profitability over FY12-FY14E leading to an improvement in its RoE from 4.3% in FY12 to 8.9% in FY14E and RoCE to improve from 6.1% in FY12 to 9.5% in FY14E. Over the last three years, Escorts Ltd has traded at a PE multiple of 6-10x. At CMP, the stock trades at an attractive multiple of 6.7x and 5.8x its FY13E and FY14E EPS of Rs11.9 and Rs13.7 respectively. Escorts also looks attractive in terms of EV/EBITDA and EV/Sales as it is trading at EV/Sales of 0.21x its FY14E sales and EV/EBITDA of 3.45x its FY14E EBITDA. Assigning a target multiple of 7.5x on FY14E we arrive at a target price of Rs 103 indicating an upside of 28.7% from current levels. We recommend to BUY the stock at current levels.

Source : Equity Bulls

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