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India Ratings and Research (Ind-Ra) expects tractor volumes to grow by around 17% yoy in FY17 (FY16: negative 8.9% yoy), driven by the improved growth prospects of the agriculture sector as well as a low base effect. Ind-Ra expects agriculture gross value added (GVA) to grow 2.9% yoy in FY17 (FY16: 1.2%; FY15: negative 0.2%).
Ind-Ra expects overall volume growth to be lower in 2HFY17 (around 14%). The currency demonetisation would have a negative impact on the tractor sales in the next couple of months, post which demand is likely to normalize aided by the government focus to boost liquidity in the rural areas on a priority basis. However, Ind-Ra observes that the industry growth in 1HFY17 has not been uniform across the country, with southern and western India seeing high double-digit growth, while growth in the northern and central India was muted. Thus, a strong uptick in growth in the northern and central markets could lead to a higher growth rate for the year.
Ind-Ra observes that currency demonetisation has impacted farmers' seeds and fertiliser purchases. If the cash crunch prevails for a longer time, it may lead to lower agriculture GVA and may have a more pronounced impact on tractor sales volumes in FY17.
Overall the Southwest monsoon situation in 2016 was much better than the previous two years and is likely to aid volume growth for the industry. The other indicators such as area sown under kharif crops as well as advance estimates of food grain production have also seen an improvement, indicating improved agricultural production this year.
The improved agricultural output should aid the loan asset quality in the tractor segment where delinquency levels have shot up. While the normalisation of asset quality is likely to be a prolonged affair, given the severity of the problem, the trends should be encouraging. The improved prospects should persuade larger participation from banks and non-banking finance companies, increasing the finance penetration and thereby aiding sales.
The long-term drivers of the sector demand such as gradual increase in farm mechanisation, increasing penetration of tractors, government impetus on increasing farm productivity and increasing usage of tractors for non-farm activities remain intact. Increasing affordability of small and marginal farmers for tractors through government initiatives as well as innovative approaches such as tractor on rentals could also significantly increase tractor demand.
Sector companies are likely to see a margin expansion of up to 300bp due to operating leverage benefits. Sector companies have around 20% of the costs fixed in their cost structure and thus volume growth could lead to a margin expansion. However, around 75% of the raw materials consumed are derived from steel and iron, and thus profitability could be impacted by volatility in these commodities.
Most sector companies have adequate capacities to grow over the next two to three years, resulting in low capex requirements primarily for new product launches as well as maintenance capex. Thus, the credit profile is likely to remain strong and further improve in FY17. Improvements in revenue and operating margins would result in higher cash flows for sector companies in FY17.
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