Escorts: Don't hop on to the hope rally

Margin gains and improvement in realisations ahead positives, but demand remains slightly warm

Escorts’ shares are up 14 per cent over the week on expectations of a pick-up in tractor volumes in the coming festival season and improvement in margins led by higher volumes and lower input costs. But, it might be a bit early to buy on hopes.

Volumes for Escorts, over 80 per cent of which come from the agri-machinery segment (primarily tractors), have been subdued on the back of weak rural demand. Tractor volumes of Escorts fell 17 per cent year-on-year in the June quarter due to unseasonal rain, crop damage and lower agri-commodity prices. Industry volumes were down over 18 per cent, helping the company gain market share, albeit marginally. While brokerages believe volumes have bottomed out and expect it to pick up in the second half, given the deficit rainfall expected in September, expect near-term volume growth (September quarter) to be muted and a repeat of the June quarter.

The positive takeaway has been higher realisations. Realisations could improve. The other area which could see more improvement is on the operational front, where Escorts has undertaken a cost reduction exercise. This is likely to end in the June quarter of FY17 and the benefits are expected to accrue subsequently.

It is the combination of this exercise and falling raw material costs which helped Escorts improve margins in the June quarter. Over 300 basis points fall in raw material costs pushed up Ebitda (earnings before interest, tax, depreciation and amortisation) margins by 85 basis points to 5.9 per cent; sequentially, these were up by 319 basis points. While FY15 margins were four per cent, analysts expect this to improve by 320 basis points to 7.2 per cent over the FY15-17 period. The Escorts management, however, is more optimistic given that it expects the number to be at 10 per cent at the end of FY17.

Given the improving margins, analysts at Karvy have increased their Ebitda and earnings estimate for Escorts by 15-22 per cent, while maintaining their revenue and volume guidance for FY16. Nevertheless, what remains crucial for Escorts as well as other players is a pick-up in demand, given that June quarter revenues were down 13.4 per cent year-on-year to Rs 978 crore, primarily on lower volumes. Thus, some analysts prefer to wait.

At Rs 164.8, down 5.2 per cent on Tuesday, the stock trades at a reasonable eight times its FY17 earnings estimate. But, given the short-term headwinds, investors should await a better entry point.