Operating profitability¹ of tractor makers is set to shrink by 300-400 basis points (bps) this fiscal because of a sharp increase in raw material prices- primarily steel- along with lower sale volume and resumption of discretionary costs.

But their credit profiles will remain stable, supported by strong and almost debt-free balance sheets, and robust liquidity, an analysis of three tractor makers, which account for 70% of the industry revenue, shows

Operating margins had expanded by 400-450 bps to 18-19% in fiscal 2021 because of better product mix, a shift towards higher horsepower (HP) tractors, lower raw material cost (especially in the first half) and curtailment of discretionary expenses such as advertising, travelling, discounts and administrative costs.

This fiscal, prices of key raw materials such as steel and pig iron (75-80% of total cost) have risen 35-40% on-year in the first nine months and discretionary costs have normalised. Despite the resultant decline, operating margin will remain healthy at 15-16% in line with the pre pandemic levels.

Three large, listed tractor makers have already seen operating profitability decline 300-350 bps in the first half this fiscal. With sales volume growth moderating to 0.7% in April-December 2021, they were able to only partially pass on higher raw material cost impact through price hikes.

Says Anuj Sethi, Senior Director, CRISIL Ratings, “We expect tractor sale volume to fall ~ 20% in the last quarter of this fiscal over the very high base of last year. Patchy rainfall has worsened the impact and lower-than-expected kharif production — albeit 0.9%² higher on-year. Furthermore, budgeted allocation for government schemes³, which had supported growth last fiscal, is 10% lower this fiscal. As a result, rural income levels have been affected this fiscal and we foresee domestic tractor sales volume declining 4-6%this fiscal⁴.”

Having said that, the expected 40-50% growth in exports, which account for 9-10% of demand, will marginally offset the impact of moderation in domestic demand.

In fiscal 2023, assuming normal monsoon and good crop profitability, domestic sales volume is expected to grow 2-4% on-year (see chart in annexure), while softening of key raw material prices is likely to expand operating margin by 100-150 bps on-year.

The sector has the potential for steady growth in the long term due to low mechanisation in the country (~2 HP per hectare). The shift towards tractors with higher HP of 41-50 will further aid growth.

Says Gautam Shahi, Director, CRISIL Ratings, “Despite moderation in operating performance, credit profiles should remain healthy this fiscal and in the next, driven by negligible debt for most players, robust cash surplus of Rs 20,000 crore and low capital expenditure requirement. Gearing for the sample set is expected to be ~0.1 time, while interest coverage will remain healthy at over 20 times.”

That said, the spread of the third wave of Covid-19 infections in the hinterland and its impact on rural demand will bear watching.

¹ Operating profit is defined as earnings before interest and taxes
² Based on first advance estimate
³ Including PM-Kisan, Interest subsidy for short term credit to farmers, Pradhan Mantri Fasal Bima Yojana
⁴ Compared to earlier estimate of growth of 3-5% as per press release dated May 18, 2021