CRISIL believes weak growth in rural income, moderation in rural infrastructure spending, higher channel inventory, and the effect of a high base will lead to de-growth in tractor sales volume by 5-7% this fiscal, from an all-time high of 8.78 lakh units in fiscal 2019.
The tractor industry is cyclical, and heavily dependent on rural incomes and monsoon. Rural incomes were impacted towards the second half of last fiscal because crop production was flat after two years of 5-6% growth, and farm profitability declined due to weak pricing. Consequently, rural wage growth was lower at 3-4% compared with an average 6% in the preceding two fiscals.
Besides, lower growth in spending on rural infrastructure has impacted non-farm tractor demand in recent months. Additionally, exports, which contribute 10-11% of sales, also declined 28% in the first quarter of this fiscal due to moderation in demand from Latin America.
That said, in the second half of the fiscal, tractor demand should be supported by a sharply improved progress of the southwest monsoon in the past few weeks, which has brought down the deficiency from 19% of the long period average (LPA) as on July 24 to a surplus of 1% of the LPA on August 28.
Says Gautam Shahi, Director, CRISIL Ratings, “The likelihood of a normal monsoon this fiscal has increased with the rains catching up in the last few weeks. This augurs well for farm income and tractor demand. Additionally, the recent budget announcements for agriculture and allied activities, the loan waivers in some states and the hike in minimum support prices for kharif crops, along with rural-development initiatives of the government, are likely to push sales.”
Despite lower volume overall for the fiscal, the earnings before interest and tax (EBIT) margin of tractor makers should be resilient at 14-16%, supported by easing commodity prices. This resilience was demonstrated in fiscal 2016 as well, when industry Ebit margin expanded by 240 bps to ~15%, even as the tractor sales volume declined 10% on-year.
To be sure, prices of steel and pig iron, which account for 90% of the raw material costs, have corrected about 7-10% between April and July this fiscal. This should help mitigate the impact of discounts being offered by tractor makers to push sales.
As for the credit outlook, over past three fiscals, the balance sheets of five CRISIL-rated tractor manufacturers1, which together account for 70% of the industry revenue, have strengthened owing to healthy cash accruals. This has led to the average debt to earnings before interest, tax, depreciation and amortisation ratio falling to 0.5 time in fiscal 2019 from ~1 time in fiscal 2016.
Says Naveen Vaidyanathan, Associate Director, CRISIL Ratings, “Despite weak sales, the credit outlook of CRISIL-rated tractor manufacturers is expected to remain stable, given resilient profitability, limited need for capex, already-strong balance sheets and healthy cash surpluses (~Rs 10,500 crore as on March 31, 2019). Further, the working capital cycle, which had witnessed some elongation over the past 7 months, should normalise gradually by the end of the second quarter of this fiscal, after a 21% on-year decline in production in the first quarter, and continued production cuts thereafter.”
The long-term growth potential for tractors remains healthy in India given lower penetration of 1.5 horse power (hp) per hectare, compared with an average 6-7 hp in the developed economies and 3-4 hp in the emerging economies. This should give hope to domestic tracker makers, though an immediate revival in tractor sales remains contingent on an improvement in purchasing power in rural markets.
1 Companies considered include Mahindra and Mahindra, Escorts, Tractors and Farm Equipment, TAFE Motors and Tractors and Force Motors