Stunted FY20 volume growth to hurt Escorts; net profit may see a 20% fall

Though the stock of tractor maker Escorts is down by half over the last year, the downward trend is unlikely to reverse any time soon given the muted June-quarter performance and a cautious outlook for the sector. Mitul Shah of Reliance Securities believes that delayed monsoon, the deficit in a few regions, lower water levels at reservoirs and high base over the previous year are the major hurdles for the tractor industry over the medium term. After three years of strong growth, analysts expect the tractor industry to post a fall of 7-10 per cent each in FY20 and FY21.

The expected pain was reflected in the performance of the company and the sector in the June quarter. The company reported a fall of 15.9 per cent in its domestic tractor volume for the June quarter; the sector fall was 14.6 per cent. This has led to a market share loss in Q1. Escorts lost its share by 20 basis points to 10.5 per cent as compared to the year-ago quarter. The reason for this is the inventory correction for better financial viability for dealers and to lower working capital requirement. The loss on a sequential basis at 448 basis points was largely due to seasonal impact. Even in July, Escorts is expected to post a 9 per cent fall in tractor sales in the domestic market and could lose some share.

The lower tractor volume is expected to weigh on the company’s margin given the negative operating leverage. The margin for the June quarter fell by 227 basis points year-on-year to 10 per cent. Analysts have cut the margin by 100 basis points and earnings per share estimates by about 20-25 per cent for FY20 and FY21.

While the company has the construction and the railway equipment segments and the latter has done well in the quarter, their overall contribution remains small. This is because 76-88 per cent of revenues and profits come from the agri-machinery (tractor) segment.

While the company is trading at 10 times its one-year forward, investors should not take an exposure given multiple headwinds for the sector which will weigh on its financials.