Key Rating Drivers & Detailed Description
Strengths:
- Healthy market position in the tractor industry
Escorts 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. Escorts 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. Escorts 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 Escorts with Kubota, Escorts Kubota India Pvt Ltd. Commercial production started in the JVs during March 2021. With increased collaboration of Escorts 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 Escorts’ 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 Escorts 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 Escorts’ 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 11% and 7%, respectively, to total revenue in fiscal 2021, adding diversity.
Product portfolio in the CE segment comprises earth moving, material-handling and road-construction equipment. The diverse product range resulted in compound annual growth rate (CAGR) of 9% during the three fiscals through 2021. 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 Escorts with the Tadano group to manufacture rough terrain and truck-mounted cranes, the market position of Escorts 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. This segment’s revenue registered CAGR of 14% in the three fiscals through 2021. Substantial orders of over Rs 400 crore as on December 31, 2021, 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. Reduction in raw material cost, due to value engineering and low employee cost, should help sustain 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 to be over Rs 6000 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, Escorts issued new equity shares to Kubota on a preferential allotment basis pursuant to which Kubota held 9.1% of Escorts’ paid-up share capital. Total investment stood at 16 billion yen (Rs 1,042 crore). Subsequent to the preferential allotment to Kubota, Escorts reduced its share capital from the shares held by the Escorts Benefit and Welfare Trust and Kubota’s stake in Escorts will increased to 10%. The company has cash surplus of over Rs 4500 crore currently 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 Escorts which signifies the importance of Escorts to Kubota. Escorts can leverage the distribution channels of Kubota to increase its exports which will help Escorts to mitigate the high dependance on the cyclical domestic tractor market. Besides, Escorts can also leverage the strong technical capabilities of Escorts 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 Escorts’ 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. 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.