ESCORTS LTD: GROWTH ON FUNDAMENTALS !!!

Scrip Code: 500495 / ESCORTS

CMP:  Rs. 521.75; Market Cap: Rs. 6,395.44 Cr; 52 Week High/Low: Rs. 531.40 / Rs. 130.40

Total Shares: 12,25,76,878 shares; Promoters : 5,26,93,738  shares – 42.99 %; Total Public holding : 6,98,83,140 shares – 57.01 %; Book Value: Rs. 150.05; Face Value: Rs. 10.00; EPS: Rs. 9.58; Dividend: 12.00 % ; P/E: 54.46 times; Ind. P/E: 49.08; EV/EBITDA: 25.05.

Total Debt: Rs. 354.79 Cr; Enterprise Value: Rs. 6,719.08 Cr.

                                                                         

ESCORTS LIMITED: ESCORTS Ltd was incorporated on December 21, 1944 in Lahore and then after partition it shifted to Delhi, India. The company was earlier known as Escorts (Agents) Pvt. Ltd and changed its name to Escorts Ltd in 1959. The company, gave its first bonus shares in May 1968, in ratio of 1 new for every 5 equity shares held, then in May 1974 in ratio of 1 new for every 2 shares held, then in May 1977 in ratio of 3 new for every 5 shares held, in May 1979 in ratio of 3 new for every 5 shares held, in May 1987 in ratio of 3 new for every 5 shares held. Company has not declared any split in face value of its shares. Escorts Limited is an engineering company, which offers agricultural tractors and construction equipment. The Company's segments are Agri Machinery, Auto Ancillary Products, Railway Equipment, Construction Equipments and Others. It is engaged in the business of manufacturing of engines for agricultural tractors, earth moving and material handling equipment, round and flat tubes, heating elements, double acting hydraulic shock absorbers for railways coaches, center buffer couplers, automobile shock absorbers, telescopic front fork and Mcpherson struts, brake block, internal combustion engine and various types of brake used by railways. Its brands of tractors include Escort, Farmtrac and Powertrac. The Jai Kisan Series of tractors comes in five new categories– ValueMaxx, LoadMaxx, AgMaxx, InfraMaxx and SuperMaxx. It also manufactures diverse range of equipment like cranes, loaders, vibratory rollers and forklifts. Escorts, in the over six decades of inception, has sold over a million tractors and over 16,000 construction and material handling equipment that have rolled out from the facilities. Escorts have over 1600 sales and service outlets and in over 40 countries. ESCORTS Limited is locally compared with Mahindra & Mahindra, Sonalika Tractors, Eicher Motors, Tractors And Farm Equipment Ltd and globally compared with John Deere Tractors of USA, New Holland Tractors of Pennsylvania, Kubota Tractors of USA, Mccormick Tractor of USA, Class Tractors of Germany, Kioto Tractors of South Korea, Belarus Tractors of Belarus, Allis Chalmers tractors of Europe, Indo Farm Equipment of Poland, Yanmar of Japan, Millat Tractors Ltd of Pakistan, Maruyama Manufacturing Company Incorporated of Japan, Thor Industries Inc, Mitubishi Motor Corp of Japan, Bayer Motoren Werke AG (BMW) of Germany, Piaggio & C. SpA of France, Porsche Automobil Holding SE of Germany, Renault Societe of France, Volkswagen Aktiengesellschaft of Germany.

Investment Rationale:

ESCORTS Ltd is one of the largest tractor and agri Machinery Company, established in 1944. It is engaged in the manufacturing of agri-machinery, construction & material handling equipment, railway equipment and auto components. The ESCORTS GROUP is among India's leading engineering conglomerates operating in high growth sectors of Agri Machinery, Material Handling & Construction Equipment, Railway Equipment and Auto Components. The Group has earned the trust of over five million customers by way of product and process innovations over six decades of its existence. Escorts has further unveiled its new 'Jai Kisan Series' of tractors, which focuses on maximizing farmer productivity by providing differentiated products that are well suited to agricultural, haulage, infrastructure as well as specialized applications. Escorts Ltd also manufactures and markets a diverse range of equipment like cranes, loaders, vibratory rollers and forklifts. Today, the company is the world's largest Pick 'n' Carry Hydraulic Mobile Crane manufacturer. Faridabad is home to all its manufacturing facilities, which include Agri-Machinery; Construction Equipment; Railways; Auto Parts. The Indian Tractor industry has always been a barometer for the state of rural economy. It is relatively young but now has become the largest market worldwide (excluding sub 20 HP belt driven tractors used in China), accounting for one-third of the global production. The other major tractor markets in the world are China and US. In India till 1960, the demand for tractor was met entirely through imports. Indigenous manufacturing of tractors began in 1961 in India and the industry has come a long way since then. The production output of the Indian Tractor industry has grown from 50,000 units in the early 1980’s to over 6,00,000 units in FY16. Volume grew at a CAGR of 10.9 % over the past decade, despite seasonal vagaries. Industry volume is expected to go up by 16 %-18 % on an annual basis in FY17 to nearly 6,96,000 units. The long term growth fundamentals of industry are strong owing to lowering of the replacement cycle, expectation of increase in MSP for key crops, scarcity of labour and ease of credit availability from Government. Also, pace of the central & state Government’s policy roll out and the final monsoon behaviour governs the short term industry performance. ICRA continues to be positive over tractor sales and believes domestic market can achieve a CAGR of 8 % to 9 % in the long term. The tractor industry sales is classified into four parts according to the tractor’s power as < 30HP, 31-40 HP, 41-50 HP and >50 HP. The 41-50 HP category holding 45.4 % market share is the most popular segment in India followed by 31-40 HP category which has 37.8 % market share as these tractors is suitable for average farmer who owns approximately 5 acres agricultural land. The > 50 HP category has market share of 6.1 % with 23,692 units. The domestic construction industry is set to become a driving force in 'Make in India' initiative. The Indian Construction Equipment Manufacturers Association (ICEMA) pegs the Construction Equipment Industry at USD 2.8 billion and expects it to grow to over USD 5 billion by 2020 on back of infrastructure growth. After facing a prolonged decline in sales since past 5 years, the industry has now witnessed a growth of 4 % during 9M FY16 due to commencement of infrastructural projects. India Union ministry expects that there would be huge opportunities for equipment manufacturers as at least 10 new express highways will be built soon. Also, highways worth at least Rs. 5 lakh cr will be built in 2016 and National Highways strength would be taken to 1.5 lakh km by March 2016 from the present 96,000 km. The Indian auto-components industry has experienced healthy growth over the last few years. Some of the factors attributable to this include: a buoyant end-user market, improved consumer sentiment and return of adequate liquidity in the financial system. The auto-components industry accounts for almost 7 % of India’s GDP and employs as many as 2 Cr people, both directly and indirectly. The industry can be broadly classified into the organised and unorganised sectors. The organised sector caters to the Original Equipment Manufacturers (OEMs) and consists of high-value precision instruments while the unorganised sector comprises low-value products and caters mostly to the after-market category. Revenues of the Indian auto-components industry grew by 11 % over the past year to Rs. 2.34 trillion in FY 16. This growth was primarily driven by healthy recovery for major OEMs in the medium and heavy commercial vehicles (M&HCV) and Passenger Vehicle (PV) segment. According to the Automotive Component Manufacturers Association of India (ACMA), the Indian auto-components industry is expected to register a turnover of USD 66 billionn by FY17 with the likelihood to touch USD 115 billion by FY21 and USD 200 billion by FY26. In addition, industry exports are projected to reach USD 12 billion by FY17 and add up to USD 30 billion by FY21, further rising to USD 80 billion by CY 2026. The sector’s contribution to manufacturing GDP is expected to double from 5 % in 2015 to 10 % in 2026. The Indian auto components industry is set to become the third largest in the world by 2025 and auto-component makers are well positioned to benefit from the globalisation of the sector. Tractor Industry is all set for a comeback. The monsoon deficit years in over last 30 years were 1982, 1986, 1987, 2002, 2004 and 2009. India experienced two years of consistent monsoon deficit in 1986 & 87 followed by a monsoon surplus year in 1988. Historical data suggests a direct correlation between monsoon level and tractor sales During 9M FY16, the Tractor Industry registered sales decline over 20 % y-o-y as the Agriculture sector struggled with second consecutive year monsoon deficit at 14 %. Deficient monsoon, worsening water reservoir, lower wholesale prices resulted in lower disposable income in rural areas impacting rural demand negatively. It is expected that, India to have adequate monsoon in FY17. Considering historical trend, it is expected that the sale of tractors to bounce back sharply post satisfactory monsoon and can register a growth of 10 % in FY17. The launch of new products by ESCORTS under the Farmtrac and Powertrac brands like XP series, Classic series, Euro series and Anti-Lift Tractor (ALT) are creating pull-based market demand amongst the prospective buyers. The new products have stunning looks backed by enhanced engine power fuel efficiency & reliability. Despite of declining tractor sales, Escorts 9M FY16 market share stands at 10.1 % as compared to 10.3 % last year. Escorts’ sales are mainly in the 31-40 HP and 41-50 HP categories. Both these segments have stiff competition and constitute over 93 % of overall tractor sales. In the 31-40 HP category Escorts, over the last few years, has at best managed to maintain its market share at 13 %. While in the northern states of UP and Bihar it has marginally ceded its share, it has made handsome gains in MP. In the 41-50 HP categories, Escorts performance has been less than satisfactory as it has lost market share 3 % since FY13 in virtually all markets except UP, where it has retained market share. Taking cognizance of its lack lustre performance, Escorts has embarked on a three pronged strategy to improve sales growth, boost market share and improve profitability. With a view to focus on improving sales and market share, Escorts has carved a separate dealer network to spearhead growth of the power brands Farmtrac and Powertrac. This new dealer network will help sharpen focus on these power brands, which constitute a bulk of the sales. Further, with a view to enhance market share in the south and west, where it has a small presence, the company is stepping up dealership additions. The company has 760+ dealerships PAN India with 65 % of these concentrated in the six states of MP, UP, Bihar, Punjab, Rajasthan and Haryana. While the company is not looking to beef up the overall dealer strength there is a conscious effort to retain dealerships in existing markets while adding some in the incumbent markets. The aim is to bring this ratio to 60:40, in favour of the established markets Escorts believes that there is substantial head room for improving profitability and has targeted RM cost reduction and employee force rationalization as immediate amelioration areas to boost margins. With a view to lower RM costs the vendor strength has been reduced to 250 from the erstwhile 400 and there is intent to further lower the vendor list. Hard bargaining with vendors to reduce costs in lieu of higher business volumes should help boost margins. It is also undertaking several value engineering projects to lower RM costs. Currently, RM costs have reduced by 2.00 % to 69.1 % and eventually the aspiration is to bring it to 67 %. Escorts (ESC) improved its market share by 0.60 % in 9MFY17, driven by key strategic initiatives planned and executed in the last 3‐4 years. It would continue to focus on increasing its share through deeper penetration and creating a parallel channel of Farmtrac and Powertrac in its strong markets. Reduction in employee cost would be a key lever to expand margins. Also, the management believes there is further room for reduction in raw material cost. Construction equipment business is on a strong footing and this should aid growth as well as margin expansion. Escorts’ tractor volumes saw robust growth of 23 % in FY17 YTD driven by normal monsoon and key strategic initiatives. During this period, its market share improved from 9.5 % to 10.1 %. Escorts would continue to focus on market share gain through tractor seeding program in untapped regions in its strong markets and increasing the pace of parallel channel creation for Farmtrac and Powertrac. To improve its visibility, Escorts has also piloted a rental model through e‐up with the government, which provides capital subsidy for farm equipment. The company is currently testing the model and would gradually scale up if it finds the model right. Exports would be a key area of focus in FY18; Escorts has new higher HP models that meet regulatory requirements. The key regions it intends to tap are Africa, Middle East and US. The management has highlighted that 450 blue collar employees are due for retirement in the next three years. It also plans to offer VRS to a similar number of employees. Since the cost of blue collar employees is high, reduction of 900 employees over the next three years would result in significant savings on employee cost. Escorts has also entered into a long‐term settlement with the labour union, wherein productivity improvement would result in employee costs remaining constant in absolute terms, even if VRS doesn’t go through. The expected 2.00 % saving in employee costs would drive EBITDA margin higher. In the construction equipment business, Escorts is confident of achieving 20 % to 25 % growth. At this pace of growth, the company expects to achieve 5 % to 6 % EBITDA margin in the long run. In the railways business, it has an order book of Rs. 1.3 billion executable over 5‐6 months. The three new products bogey and axle‐mounted disc brakes, and automated door systems it has launched offer a market opportunity of Rs. 5 billion. Escorts are also open to an inorganic acquisition in the railways business. In last Union Budget, Government had proposed and presented its vision to double farmers’ income by 2022 and to support its vision, the Government has undertaken significant measures. Pradhan Mantri Fasal Bima Yojana to stabilize farmers income and has replaced the NAIS, which provides crop insurance to farmers on liberal terms. This should go a long way in raising farmers’ income security. Rs 5,500 crore has been allocated under the PMFBY. This scheme aims at supporting sustainable production in the agriculture sector. Escorts is rightly placed to be the dependable outsourcing partner of world's leading engineering corporations looking at outsourcing manufacture of engines, transmissions, gears, hydraulics, implements and attachments to tractors, and shock absorbers for heavy trailers. In today's Global Market Place, Escorts is fast on the path of an internal transformation, which will help it to be a key driver of manufacturing excellence in the global arena. For this they are going beyond just adhering to prevailing norms, & are setting their own standards and relentlessly pursuing them to achieve our desired benchmarks of excellence. Escorts surely a best bet looking at the factors and is a best stock in the sector.

Outlook and Valuation: 

ESCORTS LTD. is one of the largest players in the tractor and agri machinery business with humble beginning in 1944. The Company operates in the sectors of agri-machinery, construction & material handling equipment, railway equipment and auto components. Its products include Agri Machinery, Construction Equipment, Auto Products such as shock absorbers, struts and telescopic front, and Railway Products. The Company offers more than 45 variants of tractors from 25 to 80 HP. Escorts Ltd, for Agri Machinery they have Four plants: Farmtrac, Powertrac, Component, Crankshaft & Hydraulic covering manufacturing area of 1,34,000 sq.m., with production capacity of 100,000 tractors p.a. It also has Poland plant, a 100 % subsidiary, has an installed manufacturing capacity of 2,500 tractors p.a Escorts Agri Machinery offers a comprehensive range of tractors with more than 45 Variants starting from 25 to 80 HP. Escorts Agri Machinery segment has positioned itself as a change leader in the agriculture sector having rolled out over 1 million tractors, ranging from hi-capacity engines to modern rugged transmissions and multi-utility taking capabilities. Escorts construction Equipment: Escorts Construction Equipment is a leading materials handling and construction equipment manufacturer. It manufactures and markets a diverse range of equipment like cranes, loaders, vibratory rollers and forklifts. Escorts, is the world largest Pick’n’ Carry Hydraulic Mobile Crane manufacturer. State-of-the-art manufacturing and assembly facility sprawling 250,000 sq.ft. of space, Capacity of 14,000 units p.a. Escorts Railway Products: Escorts Ltd has played a major role in the modernization of Indian Railways with over 40 years of rich experience in manufacturing of critical railway systems. The manufacturing plant spread across an area of over 12,500 sq. meters, Houses superior production and testing facilities, inclusive of a research and development centre; ISO 9001:2008. Product offerings include brakes, couplers, shock absorbs, rail festering systems, composite brake blocks and vulcanized rubber parts. Escorts Auto Products (EAP): Pioneered the manufacturing of automotive shock absorbers in India and it continues to be one of the leading manufacturers of auto suspension products. Plant spread across in an area of 2,25,000 sq.ft., Capacity to produce 3.2 million shock absorbers & struts and 0.3 million front forks. It also trades in oils and lubricants, implements, trailers, tractors, compressor accessories and spares, construction and aero business. It offers Euro Series under Powertrac; Classic Series in 41-50 HP under Farmtrac brand, and FT 6055 Xtra Torque Tractor with approximately 20 speed transmission. Engineering And Maintainace contributes the largest chuck to the company’s top-line at 79 % of total sales. Though it is not their most profitable segment it is the highest contributor to the company’s profit at 7.6 % at operating level. ECE is the company’s second biggest top-line contributor at 13 % but currently suffers loss at operating level. A much smaller segment, Railway Equipment’s at 6 % of top-line contribution is the company’s second most profitable business at 13 % at operating level. Over the period FY12 -15, policy paralysis had led to a severe logjam, bringing infrastructure development to a screeching halt. As a result, Escorts’ construction equipment segment revenues de-grew at a 3-year CAGR of 19 % during FY12-FY16 and there were losses at the EBIT level. With the monsoon progressing well and government spending on infrastructure projects at an all-time high, the fortunes of this segment have started to look up. This should lead to a recovery in the demand for construction equipment. Escorts’ railway segment revenues have de-grown at a 3 year CAGR of 8 % Rs. 205 crore in FY16. With the Railways being a thrust area for the government which is expected to spend Rs 1 lakh crore per annum over the next five years and 100 % allowance in FDI, this segment opens a huge opportunity for Escorts as it is one of the major vendors to the Railways. Escorts supplies manufactured products like brakes, couplers and shockers which has combined market size of Rs. 500 crore to the Railways. It has introduced two new products – Bogey Mounted Brake System (completed testing) and Axle Mounted Brake System (ongoing testing), which are in advanced stages of deployment and are Rs. 300 crore opportunity. Escorts’ has a presence only in three categories, viz., Earthmoving-Backhoe Loaders, Material Handling - Pick and Carry cranes and Road Building-Compactors. And it is expected that all the segments to do well in the short to medium term. Escorts by virtue of being a dominant player in all these segments is expected to be one of the biggest beneficiaries. The ECE segment expected to breakeven by FY17. The ECE volumes stood at 698 units in 3Q FY16. ECE is required to sell 750 units in a quarter in order to achieve its break-even point, The team is confident of breaking even from FY17 onwards due to initiatives like realizing better Average Selling Price (ASP), inclination towards higher contributing model and cost reduction. ERP new products to further enhance profitability Escorts has over 40 years of rich experience in manufacturing of critical railway systems (Safety and comfort) and has played a major role in the modernization of Indian Railways. ERP’s existing products contributes about Rs. 1,837 mn towards Escorts revenue in FY15. ERP team received a development order for Axel Mounted Disc Brakes in 2Q FY16 and company expects to execute the order by end of FY16. The new segment has a market potential of Rs. 3 billion with only one competitor. Escorts scouting for strategic partner to divest & reducing losses in EAP segment EAP pioneered the manufacturing of automotive shock absorbers in India. Its key customers are BEML, Tata Motors, TVS, Maruti Suzuki, Eicher Motors, Piaggio, Polaris and Yamaha. Escorts Management is actively scouting for strategic partner to divest EAP segment. The Company is looking forward to reduce its losses in EAP segment through cost saving from VRS and better sales portfolio rationalization in FY17. These measures are expected to yield positive results in FY17. Escorts exhibited strong volume growth of 29.5 % YoY with 4,247 units in February. This growth comes on the back of 16.3 % YoY growth in January & 27.4 % YoY growth in Q3FY17. On a YTD basis April-February, Escorts’ domestic tractor volumes have grown at 23 % YoY to 51,581 units against industry growth of 18 % YoY. The management expects to end FY17 at a growth rate of 23 % YoY. In Q1FY8E, the company expects growth to taper down to 10-15 % due to base effect. Pre-demonetisation, the industry was growing a high rate of 20 % YoY. In November, the domestic tractor industry witnessed de-growth of 13 % YoY & single digit growth of 8 % YoY in December. In the same period, Escorts outperformed the industry with flat performance in November & 12 % YoY growth in December. As per the management, the outperformance is attributable to poor winter rains in southern India, where Escorts does not have a strong presence. After a year of strong 20.2 % growth in FY14, domestic tractor sales fell 13 % YoY in FY15 due to poor Kharif harvest & lower Rabi sowing due to dipping reservoir levels. A second consecutive year of deficient rainfall which was 14 % lower than normal impacted agriculture output and led to a decline of the tractor industry by 11 % in 2015-16. In the same period of FY14-16, Escort’s volumes declined at 28 % CAGR. The primary reasons for Escort’s underperformance were gaps in the product portfolio and lack of focus on growing markets like the south & west region that together contribute 47 % of the total market. However, in YTD FY17, Escort’s volumes have outpaced industry volumes, growing 23 % YoY vs. industry growth of 18 %, with market share gain of 0.30 %. This strong growth is on the back of new products launched like 10 new models launched in the last two years, increased focus on opportunity markets of south & west region and separate Powertrac which is its economy brand & Farmtrac brand which is its premium brand in its strong northern market. The management expects industry growth of 18-20 % in FY17E & 6-8 % in FY18E.And can have a tractor volume CAGR OF 10 % in FY17-19E. To improve its visibility, Escorts has also piloted a rental model through tie‐up with the government, which provides capital subsidy for farm equipment. The company is currently testing the model and would gradually scale up if it finds the model right. Exports would be a key area of focus in FY18; ESC has new higher HP models that meet regulatory requirements. The key regions it intends to tap are Africa, Middle East and US. The management believes there is further room of 1.00 % reduction in raw material cost through value engineering. Going ahead in FY18, the monsoon is likely to play a critical role. Yet, as sowing in most regions is healthy, the season would begin on a strong note. Margin expansion through employee cost savings would be a strong lever for earnings growth. EBITDA margin is likely to expand from 4.1 % in FY16 to 10.3 % in FY19 as a result of cost rationalizing. Escorts are taking initiatives to lower raw material costs to 68 % of sales in FY19 from 71 % in FY15 through vendor rationalizing and value engineering. It targets to reduce employee cost to 8.9 % of sales through VRS in the next three years from 12.3 % of sales in FY16. It is expected that the revenue/PAT CAGR of 12 %/40 %, driven by EBITDA margin expansion of 2.80 % to 10.3 % over FY17‐19. At the current market price of Rs. 521.75, the stock is trading at a PE of 23.93 x FY17E and 15.90 x FY18E respectively. The company can post Earnings per share (EPS) of Rs. 21.80 in FY17E and Rs. 32.80 in FY18E. It is expected that the company’s surplus scenario is likely to continue for the next three years keeping its growth story in the coming quarters also.

KEY FINANCIALS	FY16	FY17E	FY18E	FY19E
SALES (₹ Crs)	3,537.60	4,118.00	4,680.20	5,170.60
NET PROFIT (₹ Cr)	77.10	138.20	269.10	349.30
EPS (₹)	11.10	21.80	32.80	42.60
PE (x)	44.80	22.90	15.20	11.70
P/BV (x)	2.70	2.50	2.20	1.90
EV/EBITDA (x)	31.40	14.50	9.90	7.50
ROE (%)	6.10	11.40	15.60	17.70
ROCE (%)	7.40	10.40	15.10	17.70

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*As the author of this blog I disclose that I do not hold  ESCORTS LTD in my any of the portfolios.

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