Why Escorts' stock may continue to ride high

Preference for mid-cap stocks and diverse operations work in company's favour

Mid-caps have been in favour for a long time, and many of them have done well for reasons well justified. With mid-caps no longer cheap, it is imperative that investors look at solid reasons to invest in them at current levels. One case that stands out, looking at its past performance and the road ahead, is Escorts. The stock, which has delivered 62 per cent year-to-date gains in 2017 (216 per cent in the past one year), can see more upsides. 

Escorts gets its sales from tractors and farm equipment (80 per cent of its revenue), and commands a 10 per cent market share in the business. Equipment manufacturing for railways, construction and automotive segments are the other three divisions. After disappointing during FY14-16, the company has bounced back with an 18 per cent rise in revenue and 55 per cent in net profit in the nine months of FY17. Analysts also predict this trend to continue (see table). Despite being smaller in terms of business and more vulnerable to rural market dynamics — not to forget the steep run-up in stock price — analysts at Karvy Stock Broking and Motilal Oswal Financial Services remain optimistic on Escorts and ascribe a 12-month target price of Rs 660 and Rs 608 respectively indicating a 12.5-22 per cent upside from the current level of Rs 541. 

The future growth is likely to be fuelled by a combination of many positives such as the steady recovery in tractor industry. Escorts’ focus is on increasing its market share in the non-core markets, and the execution of its railways division order book at an all-time high of Rs 130 crore. The company’s cost-cutting initiatives have already helped it better its operating margins from 3.8 per cent a year-ago to 8.4 per cent in the December quarter, and there is more room for gains. A revival in demand for construction equipment led by an improvement in mining activities should also help Escorts sustain its good show in FY18. 

Analysts at Phillip Capital expect Escorts to post 11 per cent compounded annual growth in tractor volumes in FY17-19 and nearly double its net profits during this period. Those at Motilal Oswal believe an improved outlook for construction equipment should help the division break even by September’17 quarter. The cost-reduction efforts by way of the ongoing voluntary retirement scheme to reduce the headcount in the next three years should also help operating profit margins expand further by 200 basis points. Overall, analysts at Motilal Oswal factor for operating margin expansion of 280 basis points (10.3 per cent) by FY19. It is these positives that fuel the rally in Escorts’ stock. Consequently, as the rally is backed by fundamentals, valuations, too, look attractive at 17.4x FY18 earnings, compared to the average mid-cap valuation of 20-24x FY18 earnings.