Detailed Rationale

CRISIL Ratings has reaffirmed its ratings on the bank facilities of Escorts Kubota Limited (EKL; erstwhile called as ‘Escorts Limited’) at ‘CRISIL AA+/Stable/CRISIL A1+’.

 

EKL registered a 3% growth in fiscal 2022, despite a 3% degrowth in the agri machinery segment (contributed 78% to overall revenues), supported by 27% growth in construction equipment (CE) and 33% growth in railways segments. The impact in agri segment was due to 15% decline in Tractor sale volumes in the domestic market; though the same was on high base of FY21. Operating margins declined by 280 bps to 12.6 % due to higher raw material costs and decline in volumes in the tractors segment. The financial risk profile however strengthened further with equity infusion of Rs 1873 crore in fiscal 2022. Cash surplus increased to over Rs 4700 crores as on March 31, 2022 from ~Rs 3000 as on March 31, 2021; a part of these funds would be utilized for capex over the medium to long term.

 

Earlier on April 26,2022, CRISIL Ratings has removed its rating on the long-term facilities of Escorts from ‘Rating Watch with Positive Implications' and upgraded the rating to 'CRISIL AA+’ from ‘CRISIL AA’. Further, ‘Stable’ outlook has been assigned to the long-term rating. The rating on the short-term bank facilities has been reaffirmed at ‘CRISIL A1+’.

 

The rating action was due to the completion of open offer through which Kubota Corporation (Kubota) increased its stake from 16.4% to 44.8%. The company’s name was subsequently changed to “Escorts Kubota Limited”. The board of EKL will continue to evaluate and consider the feasibility of cancellation of all the residual stake held by the Escorts Benefit and Welfare Trust (besides the pending capital reduction), without payment of any consideration, and merger of Escorts Finance Ltd, into EKL, subject to necessary approvals. The board will also evaluate and consider the feasibility of merger of Kubota Agricultural Machinery India Pvt. Ltd (KAI) & Escorts Kubota India Private Limited (EKI), with EKL, subject to necessary approvals. As of result of cancellation of residual stake in the trust and upon successful completion of the mergers, the stake of Kubota in EKL can reach a maximum of 53.5%.

 

EKL’s importance for Kubota will increase substantially going forward. The agri machinery and construction equipment (CE) segments will also gain direct benefit from the technology and operational efficiencies Kubota will bring. EKL’s overall business profile is expected to improve with completion of the transaction and merger of existing JVs with expected increase in scale of operations, which is substantially higher compared to earlier expectations. Over the long term, EKL will benefit from expansion of product portfolio and geographic base for the company along with access to technology improving the overall efficiency of the operations.

 

The strong parentage of Kubota and increased business, technical and managerial support will benefit the credit profile of EKL. Further, the company will also engage with Kubota for formulating the business strategies and organization structure.

 

The ratings continue to factor in the company’s healthy business risk profile, backed by an established market position in the tractor segment, diversified revenue profile, healthy operating efficiency and strong financial risk profile and liquidity. These strengths are partially offset by high dependence on the tractor industry, limited presence in export, west and south India markets, modest performance of the CE segment, and susceptibility to volatility in raw material prices.

Analytical Approach

CRISIL Ratings has combined the business and financial risk profiles of EKL and all its subsidiaries and proportionately consolidated joint ventures (JVs) to the extent of its shareholding in these entities. All these entities, collectively referred to as EKL, have significant business and financial linkages and common management.

 

CRISIL ratings has factored in distress support from the parent, Kubota given the strategic importance of EKL to Kubota.

 

Please refer Annexure - List of Entities Consolidated, which captures the list of entities considered and their analytical treatment of consolidation

Key Rating Drivers & Detailed Description

Strengths

Healthy market position in the tractor industry

EKL is the fourth largest player in the tractor segment in India (after Mahindra & Mahindra Ltd ['CRISIL AAA/Stable/CRISIL A1+'], Tractors and Farm Equipment Ltd ['CRISIL AA+/Stable/CRISIL A1+'], and International Tractors Ltd), backed by an established legacy of more than 70 years. It offers a wide range of tractors under the Farmtrac and Powertrac brands. EKL also sells 10-30 horsepower tractors under the Steeltrac brand through its JV with the Rajkot-based Amul group.

 

Revamping of the product portfolio over the past three fiscals, healthy financing tie-ups and expanding dealer network have helped sustain the market share in key geographies. Products introduced to serve local needs in opportunity markets, such as west and south India, and improving dealer and financing penetration should help increase diversity in revenue and market share over the medium term.

 

Further, merger of the JVs will strengthen the business risk profile. EKL has 40% stake through preferential issue in Kubota Agri Machinery India Pvt Ltd (KAI), the marketing and sales venture of Kubota in India, which it acquired for a consideration of Rs 90 crore (completed in October 2020). There is another 40:60 JV of EKL with Kubota, Escorts Kubota India Pvt Ltd. Commercial production started in the JVs during March 2021. With increased collaboration of EKL with the Kubota group, the company’s market position in the high-end utility tractor market is likely to improve in both the domestic and exports markets.

 

While the company has 10-11% share in the domestic tractor market with reasonable market share in eastern, northern and western markets in India, it has relatively modest presence in the southern states, which are witnessing better growth than EKL’s main markets. Therefore, its market share has witnessed nominal gains only in the recent past.

 

Further post-merger of the JVs, the combined share of EKL and Kubota in the domestic market will increase to 13-15%. Enhancing the distribution network and market share in the southern and western markets could lead to faster improvement in EKL’s market position in the tractor segment.

 

Diversified revenue profile

While tractors are the mainstay for revenue and will continue to drive growth, the CE and railway equipment businesses contributed 14% and 9%(compared to 11% and 7% in fiscal 2021), respectively, to total revenue in fiscal 2022, adding diversity.

 

Product portfolio in the CE segment comprises earth moving, material-handling and road-construction equipment. The diverse product range resulted in healthy growth over the past 4-5 years resulting in contribution of 14% to total revenue in fiscal 2022. Moreover, the company’s dominant position in the pick-and-carry crane segment and expected benefit due to business synergies with Kubota leading to improving product portfolio will drive growth over the medium term. Furthermore, through the JV of EKL with the Tadano group to manufacture rough terrain and truck-mounted cranes, the market position of EKL in the rough terrain cranes segment is likely to improve.

 

Revenue in the railway equipment business is derived from sales of brakes, suspensions, and couplers. Substantial orders of over Rs 440 crore as on March 31,2022, provide strong revenue visibility.

 

Healthy operating efficiency

The operating margin improved to 15.4% in fiscal 2021 from 6.9% in fiscal 2017, driven by the cost reduction initiatives undertaken over the past three fiscals, benefits derived from operating leverage and exit from the loss-making automotive (auto) component business. However, the operating margin declined to 12.6% in fiscal 2022 due to increased material costs and moderation in tractor volumes in line with the industry trends. Reduction in raw material cost, due to value engineering and low employee cost, should help in improving the profitability,

 

Small but gradual improvement in the performance of the CE division has also benefitted the company. Margins for the segment are expected above 4-5% over the medium term while the overall operating margin is expected at 13-14% over the medium term.

 

Strong financial risk profile, supported by robust liquidity

The already strong financial risk profile has seen a significant improvement with infusion of fresh equity of Rs 1873 crore. The net worth is estimated at Rs.7538 crore post the equity infusion. Reliance on debt is not expected to be material, leading to continuing robust debt protection metrics.  Cash accrual is expected to be comfortable at >Rs.1000 crores over the medium term and will sufficiently cover capex. Also, surplus liquidity may be used to fund additional plans, once confirmed with Kubota.

 

In July 2020, EKL issued new equity shares to Kubota on a preferential allotment basis pursuant to which Kubota held 9.1% of EKL’s paid-up share capital. Total investment stood at 16 billion yen (Rs 1,042 crore). Subsequent to the preferential allotment to Kubota, EKL reduced its share capital from the shares held by the Escorts Benefit and Welfare Trust and Kubota’s stake in EKL increased to 10%. The company has cash surplus of over Rs 4700 crore as on March 31,2022 and utilisation of fund based working capital lines is also minimal.

 

The company is in the process of drawing up its medium-term plans for investment in various businesses, including enhancing collaboration with Kubota. As the company is operating at almost optimal utilisation within the tractor segment, it may undertake material investments for enhancing the product profile.

 

Strong parentage of Kubota Corporation

Established in 1890 Kubota Corporation is a global manufacturing company, specializing in agriculture, water and living environment products with a worldwide network in over 120 countries. With 186 companies in the group across diverse geographies, Kubota has recorded revenues of ~USD 17 bn in CY 2021. Kubota is the leader for Combine Harvester in Asia and global leader in mini excavators.

 

Kubota has invested about Rs.9000-9500 crores and acquired 44.8% stake in EKL which signifies the importance of EKL to Kubota. EKL can leverage the distribution channels of Kubota to increase its exports which will help EKL to mitigate the high dependance on the cyclical domestic tractor market. Besides, EKL can also leverage the strong technical capabilities of Kubota to launch new products.

 

Weaknesses

High dependence on the cyclical domestic tractor market, and limited presence in export, south and west markets

In India, demand for tractors is determined by multiple variables, such as monsoon, crop prices and availability of finance etc. Around 96% of EKL’s tractor sale volumes are derived from the domestic market, which makes it highly dependent on performance of the domestic market. For instance, operating performance was constrained in fiscals 2015 and 2016 due to slowdown in the tractor industry, leading to a fiscal-on-fiscal volume decline of 13.3% and 13.7%, respectively. Share in overall export volumes was low at 4-5% over last few years. Furthermore, the group has limited presence in opportunity markets. However, by expanding the dealer network, the company was able to gain market share during the downturn.

 

Modest performance of the CE segment

The CE segment was making loss in the recent past due to high fixed costs and cyclicality. However, the earnings before interest and tax (EBIT) margin improved to 3.6% in fiscal 2020 from a negative 2.3% in fiscal 2017. The turnaround was led by a change in the product mix (increasing proportion of higher tonnage equipment) and cost rationalisation initiatives such as vendor rationalisation and price renegotiation.

 

Revenue and EBIT margin were impacted materially in the first half of fiscal 2021 due to Covid-19; however, performance started improving from the third quarter. EBIT margin for fiscal 2022 was at 2.4% compared to 3.6% primarily due to higher material costs. Given high input costs and considerably fixed-cost intensive nature of operations, profitability will remain vulnerable to intense competition and economic slowdown.

 

Susceptibility to volatility in raw material prices

The price of the key raw material (steel) is volatile. Operating profitability is also constrained by the limited ability to pass on any increase in raw material cost to customers in a timely manner due to intense competition. The railway equipment business is also largely tender based, limiting the scope to pass on sizeable cost changes, unless specifically covered in contracts.

Liquidity: Superior

Cash accrual is expected at over Rs.1000 crore annually, against negligible debt obligation. The company currently has cash and cash equivalents of over Rs.4700 crores. Bank limit remained unutilized over the six months through June 2022. The company has minimal dependence on external debt. Internal accrual, cash and equivalent and unutilized bank lines will be sufficient to fund debt obligation as well as incremental capex and working capital requirement.

 

ESG Profile of Escorts Kubota Limited

CRISIL Ratings believes that EKL’s Environment, Social, and Governance (ESG) profile supports its already strong credit risk profile. The auto sector has a significant impact on the environment because of the high greenhouse gas (GHG) emissions of its core operations as well as products. The sector also has a significant social impact because of its large workforce across its own operations and value chain partners and focus on innovation and product development

 

Key ESG highlights:

• EKL has begun sustainable report in compliance with GRI standards from FY2020 .The company discloses key parameters such as scope 1, scope 2 greenhouse gas emission, hazardous waste and particulate matter intensity. In FY22, EKL have further disclosed one of the categories in Scope 3 emission. The company is in the process of drafting its goals and strategy with respect to reduction of emission of greenhouse gases and generation of hazardous wastes. EKL will also submit commitment to Science based targets initiative to solidify its plan to reduce carbon emission in the future.
• EKL has also undertaken initiatives to conserve water by recycling wastewater which along with other conservation initiatives has led to reduction in water consumption across divisions. Besides, it has undertaken initiatives through behavioral and process changes to reduce energy consumption which has led to significant energy savings in FY22.
• EKL spent Rs.16 crores(~2% of PAT in FY22) for CSR activities while also spending for sustainable product development. Women contribute 16.67% of EKL’s board(three women out of 18 board of directors) and EKL has committed to hire more women across all levels to improve gender diversity. In FY22, EKL’s proactively established formal structure to screen suppliers based on ESG. Over the medium term, EKL will perform supplier audits on ESG for its suppliers and will also introduce capacity building programmes on ESG for critical suppliers.
• The governance structure is characterized by 50% of its board comprising independent directors(none of them having tenure exceeding ten years), strong investor grievance redressal mechanism and extensive disclosure.

 

There is growing importance of ESG among investors and lenders. EKL’s commitment to ESG principles will play a key role in enhancing stakeholder confidence, given its high share of shareholding by foreign investors/companies.

Outlook: Stable

CRISIL Ratings believes Escorts will benefit from the parentage of Kubota. Escorts can leverage the technical capabilities and export channels of Kubota to further improve its market position in the agricultural equipment segment over the medium term. Besides performance in the CE segment expected to improve while maintaining its strong financial risk profile and robust liquidity.

Rating Sensitivity Factors

Upward Factors:

• Increased strategic importance to Kubota
• Gain in overall market share in tractors to 13-14%, supported by better presence in southern and western markets
• Improvement in business diversity due to sharp increase in scale of non-agri segments
• Sustenance of strong financial risk profile and healthy liquidity

 

Downward Factors:

• Sharp deterioration in market share to below 7-8% due to increased competitive intensity, also affecting operating profitability
• Sizeable, debt-funding capex or acquisition, materially impacting key credit metrics
• Material reduction in liquidity surplus
• Weakening credit profile of Kubota

About the Company

Mr H P Nanda set up the Escorts group through Escorts Agents in 1944 in Lahore. After moving to Delhi post-independence, Escorts Agents was reconstituted into a public limited company named Escorts Agents Pvt Ltd. The company got its current name (Escorts) in January 1960. Escorts currently operates in three segments: tractors, construction equipment and railway equipment. It has diversified into other products, such as agricultural machinery, auto components, railway equipment, industrial and construction equipment, telecommunication equipment, healthcare and software services. However, some of its non-core businesses, such as telecommunications (sold Escotel Communications in fiscal 2004), healthcare (sold Escorts Heart Institute & Research Centre in fiscal 2005), and software (in fiscal 2005) and auto components (in fiscal 2017) have been divested. Escorts also merged Escorts Construction Equipment Ltd, Escotrac Finance and Investments Pvt Ltd, and Escorts Finance and Leasing Pvt Ltd with itself in 2012.

 

In 2018, Kubota and Escorts set up a high-end tractor manufacturing capacity in Haryana through a 60: 40 JV, Escorts Kubota India Pvt Ltd. The manufacturing facility has capacity of 50,000 units per annum. During fiscal 2019, company has also entered into a JV with Tadano group to produce specialized cranes.

 

The company is managed by a third-generation family member, Mr Nikhil Nanda, who is the chairman and managing director. It has five manufacturing facilities in Faridabad, Haryana and one in Poland. Total annual capacity is 1.2 lakh tractors and 10,000 units in CE.

Any other information: Not applicable