Recommendation From Auto- Tractors Sector

This column gives you scrip chosen by the research team during the fortnight that is fundamentally strong and expected to give good capital appreciation over a time period of 1 year.

ESCORTS : MAKING THE MOST OF TAILWINDS

HERE IS WHY
☛Low-interest rate and economic recovery put the auto sector in a sweet spot
☛Tractor Industry to outperform the auto sector
☛Change in product mix to improve margins on a sustainable basis

The automobile sector remains a key beneficiary of economic recovery and low interest rates. Monthly auto sales numbers reflect this trend. Even before this recovery, there was a substantial divergence in the domestic tractor industry’s performance against the other pockets of the auto industry in the post-pandemic months. Retail tractor volumes have grown around 40 per cent on yearly basis in June-October 2020 against the doubledigit decline in other segments of auto. What has helped such a better performance of tractors is the convergence of various supportive factors for rural cash flows and sentiment, such as remunerative Rabi harvest, higher Kharif production, normal monsoon, continued government focus on farm incomes and rural infrastructure, all acting as tailwinds for the sector.

Escorts, which derives majority of its earnings from the sales of the tractors, is best placed to exploit this opportunity. 

The company would be expanding its capacities by around 2,500 per month, taking total capacities to 1.5 lakh units per annum at a cost of around Rs 100 crore. Total capex spend for FY21 is seen at around Rs 250 crore. The reason they have to increase their capacity is because the company was already operating at peak capacity. Demand continues to outstrip production, and with inventory levels low hence we expect the industry to grow at double digits for the next one year. Escorts is likely to surpass this growth rate. 

Besides the sector tailwinds, the company is also making moves to make the most out of this opportunity. This is being witnessed in the quarterly results of the company for Q2FY21. There was stellar margin improvement due to favourable change in product mix where the contribution of higher product increased from 45 per cent in Q2FY20 to 65 per cent in Q2FY21. The company also has other divisions such as construction equipment and railway equipment. As the economy picks up and infrastructure spending increases, the other divisions of the company will also start contributing. 

For Q2FY21, Escorts clocked a remarkable operational performance with revenue growing by 24 per cent YoY to Rs 1,639.7 crore against Rs 1,323.9 crore in 2QFY20 while EBITDA margins stood at 18 per cent up 878 bps YoY. The improvement in margins was attributable to tractor division which registered 20 per cent EBIT margins for the quarter that was up by 973 bps on yearly basis. Consequently, standalone profit came in at Rs 228.9 crore, up 118.9 per cent YoY. Currently the share of company is available at price to earnings (PE) ratio of around 23 times. Besides, Escorts also has investment in other companies, the value of which comes to around Rs 2,700 crore, which means around Rs 200 per share. Looking at higher growth potential, improving operational efficiency and reasonable pricing, we advise our readers to invest in this scrip with return expectation of 20 per cent in the next one year.