Street remains bullish on Escorts despite a 2.5x run since March

Despite witnessing strong volume growth in recent quarters, the company’s market share has declined in the first half of the year owing to production constraints.
Shares of Escorts — the country’s second-largest tractor maker — have gained 156 per cent since their March intra-day lows. This has been aided by the demand for tractors, which has remained healthy despite unprecedented disruption to the economy. 

The better-than-expected demand comes on the back of a robust rural economy, which has been spurred by good rainfall for the second straight year, higher Kharif sowing, and stable crop prices. 

This has translated into strong earnings growth, with the firm’s operating profit jumping more than 50 per cent in H1FY21 to Rs 421 crore, compared to Rs 269 crore in the year-ago period. 

Analysts, therefore, believe there are more gains ahead — both in terms of financial performance and share price.

Encouraged by abundant rainfall and higher soil moisture, the rabi season started on a positive note, with sowing up 3 per cent on last year’s high base. 
Analysts say tractor volumes could accelerate over the next two years, thanks to the government’s move to support farmers. These include increasing the MSP for rabi crops, and improving availability of finance via NBFCs and private banks. 

In the near term, though, there may be a marginal impact on demand in the north owing to the farmer protests.

“We expect the domestic tractor industry to grow 15 per cent year-on-year (YoY) in FY21, followed by a 10 per cent YoY growth in FY22,” said Hitesh Goyal, research analyst, Kotak Securities. He added that tractor volumes could grow at a compound annual growth rate (CAGR) of 11 per cent through FY20-23.  

Despite witnessing strong volume growth in recent quarters, the firm’s market share declined in H1FY21 due to production constraints. With supply chains normalising and capacity expansion plans taking off, analysts at JPMorgan expect Escorts to recoup some of its lost market share in the next two quarters. 

The tie-up with Kubota Tractors is also seen boosting exports. “We believe Escorts can export 15,000-20,000 more tractors over the next five years, as Kubota opens its distribution network. We expect export volumes to grow at a CAGR of 23 per cent over the next three years,” said Goyal.

Even as business prospects improve, valuations remain reasonable despite the sharp surge in its share price. The stock is trading at a 12-month forward P/E multiple of 19.4x — a shade lower than its 5-year average of 19.7x. 

 “Valuations could improve, given a favourable (business) cycle, scope for market share gains and margin expansion. The Kubota deal offers a competitive edge and opens up multiple avenues for growth,” said analysts at JPMorgan in a note.

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