Automobiles October 28, 2014

Escorts

Bloomberg: ESC IN Reuters: ESCO.BO

BUY

India Research

COMPANY UPDATE

Recommendation

CMP: Rs163

Target Price: Rs245

Previous Target Price: Rs245

Upside (%) 50%

Stock Information Market Cap. (Rs bn / US$ mn) 20/326

52-week High/Low (Rs) 168/90

3m ADV (Rs mn /US$ mn) 471/7.7

Beta 1.4

Sensex/ Nifty 26,753/7,992

Share outstanding (mn) 123

Stock Performance (%) 1M 3M 12M YTD

Absolute 11.4 32.6 74.6 18.4

Rel. to Sensex 11.4 30.2 35.3 (6.3)

Performance

Source: Bloomberg

Analysts Contact Mitul Shah

+91 22 6184 4312

mitul.shah@karvy.com

0

50

100

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15,500 17,500 19,500 21,500 23,500 25,500 27,500 29,500

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Ap

r-1

4

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-14

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Sensex (LHS) Escorts

Key Take-away from Management Road show

We recently hosted road show with Escorts’ senior management.

Management discussed business prospects for its major segments i.e. Agri

business, construction equipment business, ancillary and Other businesses.

Key trigger for the company would be turnaround of its construction

equipment business coupled with narrowing off losses in ancillary business.

Company targets double digit EBIDTA margin with expected recovery in

construction equipment business, strategic divestment of ancillary business

and improvement in tractor volumes over next 2-3 years. Company already

started taking various initiatives to lower cost including VRS and value

engineering. Management’s key focus areas are new product development,

reduction in raw material cost by change of design, rationalize work force,

lower the breakeven point for loss making entities and hiving off undesirable

business segment. We believe that economic recovery would lead to turn

around of construction equipment business by FY16E and governments’

thrust on agri sector would result in healthy tractor volumes going forward.

Agri Business – New Products to Improve Market share & Margins:

Management indicated series of new product launches on new platform in

higher HP tractor segment by FY17. These would be developed with aid from

global experts to bring down material cost and improve margins of agri

business. Company targets 3-4 percentage point reduction in RM/Sales over

next 2 years. Moreover, other cost efforts in terms of VRS and marketing

initiative in Southern region would help on volumes and margin expansion.

Turn-around in Construction Equipment Biz to boost Profitability in FY16:

Company has brought down its breakeven point for construction equipment

segment from 1000 to 850 units per quarter by various cost cutting initiatives.

Management expects turn around by Q4FY15 and sizable bottom line

contribution from this business segment to overall group by FY16.

Outlook & Valuation

We maintain our estimates and retain target price of Rs 245, valuing the stock

at 10xFY17E EPS. In view of expected recovery in its construction equipment

business and attractive valuation of 6.7xFY17E EPS, we reiterate our “BUY”

recommendation on Escorts. Risk Reward is highly favorable at CMP.

Upward revision to our margin estimates is likely.

Key Financials (Standalone)

Y/E Sep (Rs. mn) Sep-12 Mar-14 Mar-15E Mar-16E Mar-17E

Net Sales 38,939 62,915 44,727 51,469 59,352

EBITDA 1,822 3,812 2,461 3,578 4,249

EBITDA margin (%) 4.7 6.1 5.5 7.0 7.2

Adj. Net Profit 692 2,416 1,521 2,351 2,920

EPS (Rs.) 5.8 20.3 12.8 19.7 24.5

ROE (%) 4.2 14.3 8.1 11.5 12.8

PER (x) 28.1 8.0 12.8 8.3 6.7

Source: Company, Karvy Stock Broking *Note: Escorts recently changed its accounting financial year from

Sept-end to March-end, therefore, FY13(Mar-14) includes financials of eighteen months (Oct-2012 to Mar 2014),

hence YoY comparison for FY13 and FY15 is not meaningful.

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October 28, 2014

Escorts

Exhibit 1: Annual Segmental Revenue Break-up (%)

Source: Company, Karvy Stock Broking

Source: Company, Karvy Stock Broking

Exhibit 2: Quarterly Revenue Break up

Source: Company, Karvy Stock Broking;

Exhibit 3: Segmental Margin Trend

Source: Company, Karvy Stock Broking;

Exhibit 4: Segmental Financials

(Rs. Mn) FY10 FY11 FY12 FY13 (6 Qtr) Q1FY15

Segment wise Revenue

Agri machinery products 24,738 29,500 29,118 51,233 9,464

Auto ancillary products 1,109 1,231 1,432 2,106 229

Railway equipment 1,978 1,923 1,488 2,558 427

Construction equipment - - 7,486 7,632 1,211

Others - 46 85 69 24

Total 27,647 32,505 39,098 63,082 11,355

Segment Result (EBIT)

Agri machinery products 2,234 1,878 2,266 4,964 782

Auto ancillary products (173) (176) (118) (296) (92)

Railway equipment 228 164 94 146 16

Construction equipment - - 14 (322) (90)

Others - - 17 (14) (3)

Total 2,289 1,866 2,271 4,477 614

Operating Margins (%)

Agri machinery 9.0 6.4 7.8 9.7 8.3

Construction equipment 11.5 8.6 6.3 (4.2) (7.4)

Overall 8.3 5.7 5.8 7.1 5.4

Source: Company, Karvy Stock Broking

Agri

machinery

73.6

Auto ancillary

3.6

Railway

equipment

3.8

Construction

equipment

18.9

Others

0.1

FY12 (Sep' 12)

Agri

machinery

80.6

Auto

ancillary

3.3

Railway

equipment

4.0

Construction

equipment

12.0 Others

0.0

FY13 (Mar '14 - 6 Qtr)

20.0 23.4 15.5 16.1 12.4 16.5 9.2 12.1 11.2 11.2 10.7

74.0 68.5 76.6 75.5 81.3 74.5 83.0 79.2 83.3 81.0 83.3

0%

20%

40%

60%

80%

100%

Dec

' 11

Mar

' 12

Jun

' 12

Sep

' 12

Dec

' 12

Mar

' 13

Jun

' 13

Sep

' 13

Dec

' 13

Mar

' 14

Jun

' 14

Construction equipment Others

Railway equipment Auto ancillary products

Agri machinery products

(10.0)

(5.0)

-

5.0

10.0

15.0

Dec

' 11

Mar

' 12

Jun

' 12

Sep

' 12

Dec

' 12

Mar

' 13

Jun

' 13

Sep

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Dec

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Mar

' 14

Jun

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Agri machinery Construction equipment Overall

(%)

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October 28, 2014

Escorts

Agri Business

Exhibit 5: Lower Intensity of Farming Yield in India

Source: FAO, Company

Exhibit 6: Industry Segment Volumes (FY14)

Source: Company, Industry

Exhibit 7: Industry Segment Volumes Market Share (FY14)

Source: Company, Industry

1. Higher HP Segment of

B/C/D and E/E+ are

growing faster than the

industry average

2. Higher HP Segment

allows for premium

pricing

A/A+ Segment: 0-27 HP

B/C/D Segment: 28-45

HP

E/E+ Segment: 46 HP+

Exhibit 8: Tractor Industry Market Share (FY14)

Source: Company, Industry

0 2000 4000 6000 8000

US

Brazil

India

Russia

Intensity of Farming Yield (KG/Hectare)

59,851

272,814

203,020

57,382

283,930

186,425

60,224

328,691

244,861

0

50000

100000

150000

200000

250000

300000

350000

A/A+ B/C/D E/E+

FY12 FY13 FY14

11%

51%

38%

11%

54%

35%

10%

52%

39%

0%

10%

20%

30%

40%

50%

60%

A/A+ B/C/D E/E+

FY12 FY13 FY14

41

24.7

10.7

10.3

5.8

M&M TAFE Escorts Ltd Sonalika JD

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October 28, 2014

Escorts

Key Highlights:

Near Term Hurdle…Long Term Positive: According to Escorts’ Management,

monsoon deficit would act negatively for the industry in Q3FY15. It has

already impacted the volumes in H1FY15. Its key market of UP witnessed

monsoon deficit to the tune of 30%, while other states like Haryana and Punjab

also witnessed higher monsoon deficit this season. Management expects low

single digit growth of ~3% in H2FY15 on a low base, which would translate

into more or less flat volumes for FY15. However, considering country’s low

intensity of farm yield, low penetration level and new governments’ strong

thrust on agriculture, company expects 8-10% growth for next year, assuming

normal monsoon. Moreover, due to lack of farm labour and other issues, trend

is directionally positive for higher usage of automation and equipments in

agriculture. These are the key drivers for long term growth of tractor industry.

South to Continue Growing: Due to sharp fall in tractor sales in Southern

region during previous three years (FY11-13), its current base is very low,

despite growth in FY14. On account of improving economic situation,

southern region was the only region which reported growth in H1FY15. At

present, few states like Karnataka and AP show better traction and company

expects these regions to continue growing in H2FY15. Escorts has been losing

opportunity from revival in southern region due to small presence in the

region. Management has been putting efforts on Sales & marketing in the

region to improve its brand image and aims to take its share from current ~4%

to 7-8% over next 3 years.

New Products to Boost Volumes and new Designs to Improve Margins:

Escorts has invested ~Rs 1.5 bn towards product development in past 2 years,

it plans to spend additional Rs 1.6-1.7 bn towards technology and product

development in agri segment. Escorts already launched new tractors from its

PowerTrac series in FY14 and it plans to launch new series of tractors from its

FarmTrac brand in FY17 to improve market shares going forward. Moreover,

it tied up with Porche consulting for designing of new tractors. Company has

also hired Mckinsey for value engineering and cost reduction by

implementing new designs. Company targets to improve margins by 2-3

percentage point by lowering RM/Sales over next 2 years. Company also sells

specialty Ferrari tractors in small quantum. These are imported tractors and

high value products with ASP of ~Rs 0.8 mn.

Lost Market Share due to Exiting Lower HP Segment and Imbalance in

Regional Growth: According to Escorts’ management, lower HP tractors has

very thin margins as compared to higher HP tractors (>40 HP). This forced

company to exit from small tractor segment and company almost exited from

<30 HP tractor segment. Management cited this as one of the key reasons

behind market share loss over past two years. Moreover, recent

outperformance of Southern region, where in it has miniscule presence, also

impacted its overall market share position.

Exports Initiatives: Escorts exports the tractors to South East Asia, Africa and

USA. It has a local assembly plant in Poland, Europe and it launched new

FarmTrac Europe series last year to cater European customers. This market is

oriented towards higher HP segment (100HP+) and Escorts offers comparable

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October 28, 2014

Escorts

product at ~30% lower price compared to peers. It would take 2-3 years for

company to establish in global markets. At present company exports ~1000

units per year (1.5% of total Slaes), which it aims to take to ~3000 units over

next 3 years.

Cost Saving Initiatives to Expand Margins: Management has taken various

cost cutting initiatives recently. It has started two years’ program along with

Mckinsey to reduce RM/Sales by 3-4 percentage point since Jun’14 and it has

already witnessed some improvement. Till now management has visibility of

saving in RM cost to the tune of Rs 1.2 bn per year, while its full impact would

be seen in FY17 only. It has also offered VRS last year and announced another

round of VRS in Q2FY15 to lower employee cost. It plans to cut its labour cost

by Rs 150-200 mn going forward. Company is also working with BCG group

to improve productivity and business effectiveness. All these steps would

result in sizable margin improvement by FY17.

No Capacity Expansion…Capex only for Product Development:

Management indicated capex of Rs 1.1-1.2 bn per year for next two years.

Company has a current production capacity of 100,000 units per annum,

which can be easily scaled up to 120,000 units by minor adjustments and

increasing production shifts. At present its tractor plants’ utilization stands at

70%, hence according to management, capacity expansion is not needed for

next 3 years. Its entire capex would be primarily towards product

development and technology upgradation.

How They are Positioned – India’s Top End

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October 28, 2014

Escorts

Construction Equipment Business

Key Highlights:

Very Competitive Industry Structure; Small Pie...More Players: According to

Management, Construction equipment industry is very competitive with

presence of over 46 big players in India. Out of these around 26 players have

manufacturing plant in India, while the balanced players import these

equipments. As per company, industry has been facing massive slow down

since past 2.5 years and hardly any player is profitable at present, due to

below 50% utilisation. Current industry size is ~55,000 units per annum in

volumes and ~USD 2.5 bn annually in value terms.

Exhibit 9: Industry Segment Volumes % (FY14)

Source: Company, Industry

Exhibit 10: Earthmoving Equipment Volume % (FY14)

Source: Company, Industry

Earthmoving Segment Contributes >75% to Industry: The Earthmoving

segment is the biggest segment, which consists of Backhoe loaders and

Excavators. These are high value and high volume products. ECE is present in

Earthmoving segment (through Backhoe Loader), Material handling and Road

construction segment (through compactors).

Escorts’ Improving Position: Escorts has small presence in Earthmoving

segment due to its non-compete agreement with JCB till 2010. Company

entered the segment with launch of Digmax-I, which was not well received by

customers. Company slowly gained ground with success of its Digmax-II and

started outperforming the industry with 12% volume growth as against

industry decline of 14% in last one year. Escorts’ market share improved from

1.4% in FY11 to 3.7% in YTD15.

Lowers Break-even point…Economic Revival to Expands Margins: Escorts

has successfully lowered its break-even point by various cost cutting

initiatives like offering VRS to few employees, change in the product mix,

design change etc. Company’s breakeven point declined from ~1000 units to

current 850 units per quarter. It is observed that construction equipment

industry has high correlation with GDP growth to the tune of R2 of 0.99, hence

expected economic recovery over next two years would result in sharp uptick

in industry volumes. Moreover’s Escorts strengthening position would benefit

company. Management expects marked improvement in company’s margins

with volume recovery in FY16.

78%

7%

5% 5% 5%

Earthmoving Eqpt Material Handling Eqpt

Road Construction Eqpt Concreting Eqpt

Material Processing Eqpt

67%

27%

6%

BacKHoe Loader Crawler Excavator Others

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October 28, 2014

Escorts

Construction Equipment Segment

Other Business Railway Business: Company has been supplying safety components like

brake system, coupler, suspension etc to Indian railway. Escorts plans to

launch series of new products including products for upcoming metro

railways over next two years. Management expects future orders from

government on defense side as well as for wagons and business would grow

in double digit over next 4-5 years. Segmental contribution of railway business

is smaller for Escorts hence relatively less focused area, though it is profitable.

Ancillary Business: Escorts has been incurring huge losses in this business,

though company has lowered its breakeven point in this business also by

various cost cutting measures. Its revenue breakeven point is ~Rs 2.8 bn as

against its reported revenues of Rs 2.1bn in FY14. Company is in the search of

strategic investor for the business keeping all options open (including hiving

off the segment). Company expects losses to narrow down with lower

employee cost on account of VRS.

Exhibit 11: Adjusted Financials

(Rs. mn) Adj Mar'13 Adj Mar'14 Mar-15E Mar-16E Mar-17E

Net Sales 38,660 42,627 44,727 51,469 59,352

EBITDA 2,079 2,740 2,461 3,578 4,249

EBITDA margin (%) 5.4 6.4 5.5 7.0 7.2

Adj. Net Profit 1,025 1,755 1,521 2,351 2,920

EPS (Rs.) 8.6 15.0 12.8 19.7 24.5

YoY growth (%) 74.1 -15.1 54.5 24.2

Source: Company, Karvy Stock Broking; Adj Financials are for 12 months ending March i.e. Adj Mar’13 = Apr’2012 to March 2013.

8

October 28, 2014

Escorts

Financials

Exhibit 12: Profit & Loss Statement (Standalone)

Y/E Sep (Rs. mn) Sep-12 Mar-14 Mar-15E Mar-16E Mar-17E

Net revenues 38,939 62,915 44,727 51,469 59,352

Operating expenses 37,116 59,103 42,266 47,891 55,103

EBIDTA 1,822 3,812 2,461 3,578 4,249

EBIDTA margin (%) 4.7 6.1 5.5 7.0 7.2

Other income 478 774 404 445 489

Interest 964 1,107 469 422 380

Depreciation 484 832 619 662 708

Profit Before Tax 880 2,688 1,777 2,939 3,650

Tax 184 275 256 588 730

Reported Net Profit 696 2,413 1,521 2,351 2,920

Net Margin (%) 1.8 3.8 3.4 4.6 4.9

Adjusted Net Profit 692 2,416 1,521 2,351 2,920

Adj. Net Margin (%) 1.8 3.8 3.4 4.6 4.9

Source: Company, Karvy Stock Broking *Note: *Note: Escorts recently changed its accounting

financial year from Sept-end to March-end, therefore, FY13 (Mar-14) includes financials of eighteen

months (Oct-2012 to Mar 2014) YoY comparison for FY13 and FY15 is not meaningful.

Exhibit 13: Balance Sheet (Standalone)

Y/E Sep (Rs. mn) Sep-12 Mar-14 Mar-15E Mar-16E Mar-17E

Equity capital 1,193 1,193 1,193 1,193 1,193

Reserves & surplus 14,947 17,121 18,433 20,533 23,244

Shareholders’ funds 16,140 18,314 19,626 21,726 24,436

Total Loans 4,599 3,504 2,504 1,804 1,104

Deferred tax liability 28 -74 -74 -74 -74

Total Liabilities and Equity 20,767 21,744 22,056 23,456 25,467

Gross block 22,963 24,220 25,313 26,633 27,833

Depreciation 7,100 7,793 8,412 9,074 9,782

Net block 15,863 16,427 16,901 17,559 18,051

Capital WIP 665 374 480 360 360

Investments 3,859 3,815 3,815 3,815 4,315

Inventory 4,966 5,510 5,790 6,560 7,548

Debtors 4,454 3,524 4,411 5,076 5,854

Cash & Bank Bal 1,306 1,608 2,016 2,700 4,145

Loans & Advances 3,075 3,596 3,334 3,671 3,471

Current Assets 13,801 14,238 15,551 18,007 21,019

Sundry Creditors 8,846 8,297 9,843 11,153 12,832

Other Current Liability 1,987 2,001 2,001 2,001 2,001

Current Liability& Provisions 13,420 13,109 14,690 16,285 18,278

Net current assets 381 1,129 860 1,722 2,741

Total Assets 20,767 21,744 22,056 23,456 25,467

Source: Company, Karvy Stock Broking *Note: *Note: Escorts recently changed its accounting

financial year from Sept-end to March-end, therefore, FY13 (Mar-14) includes financials of eighteen

months (Oct-2012 to Mar 2014) YoY comparison for FY13 and FY15 is not meaningful..

9

October 28, 2014

Escorts

Exhibit 14: Cash Flow Statement (Standalone)

(Rs. mn) Sep-12 Mar-14 Mar-15E Mar-16E Mar-17E

EBIT 1,338 2,980 1,842 2,916 3,541

Other Income 478 774 404 445 489

Depreciation & Amortisation 484 832 619 662 708

Interest paid(-) (964) (1,107) (469) (422) (380)

Tax paid(-) (184) (275) (256) (588) (730)

Extra Ord Income 28 40 0 0 0

Operating Cash Flow 1,180 3,245 2,141 3,013 3,628

Change in Working Capital 841 (446) 676 (178) 427

Cash flow from Operations 2,021 2,799 2,817 2,835 4,055

Capex (1,940) (1,105) (1,200) (1,200) (1,200)

Strategic Investment (155) 36 0 0 0

Non Strategic Investment (46) 8 0 0 (500)

Cash flow from Investing (2,141) (1,061) (1,200) (1,200) (1,700)

Change in borrowing 1,741 (1,095) (1,000) (700) (700)

Others (2,178) (82) 0 0 0

Dividends paid(-) (171) (258) (209) (251) (209)

Cashflow from Financial

Activities (608) (1,435) (1,209) (951) (909)

Change in Cash (729) 302 408 684 1,446

Opening cash 2,034 1,306 1,608 2,016 2,700

Closing cash 1,306 1,608 2,016 2,700 4,145

Source: Company, Karvy Stock Broking

Exhibit 15: Key Ratios

Sep-12 Mar-14 Mar-15E Mar-16E Mar-17E

Revenue Growth 20.2 61.6 -28.9 15.1 15.3

EBITDA Margin 4.7 6.1 5.5 7.0 7.2

Net Profit Margin 1.8 3.8 3.4 4.6 4.9

ROCE (%) 7.2 16.3 8.9 11.9 13.3

ROE (%) 4.2 14.3 8.1 11.5 12.8

Source: Company, Karvy Stock Broking

Exhibit 16: Valuation Parameters

(Rs. mn) Sep-12 Mar-14 Mar-15E Mar-16E Mar-17E

EPS( Rs) 5.8 20.3 12.8 19.7 24.5

P/E (x) 28.1 8.0 12.8 8.3 6.7

P/ BV (x) 1.2 1.1 1.0 0.9 0.8

EV/ EBITDA (x) 12.5 5.6 8.1 5.2 3.9

Fixed Assets Turnover Ratio (x) 2.4 3.7 2.6 2.9 3.3

Debt / Equity (x) 0.29 0.20 0.13 0.08 0.05

EV/ Sales (x) 0.6 0.3 0.4 0.4 0.3

Source: Company, Karvy Stock Broking *Note: *Note: Escorts recently changed its accounting

financial year from Sept-end to March-end, therefore, FY13 (Mar-14) includes financials of eighteen

months (Oct-2012 to Mar 2014) YoY comparison for FY13 and FY15 is not meaningful..

10

October 28, 2014

Escorts

For further enquiries please contact:

research@karvy.com

Tel: +91-22-6184 4300

Disclosures Appendix

Analyst certification

The following analyst(s), who is (are) primarily responsible for this report, certify (ies) that the views expressed herein accurately reflect

his (their) personal view(s) about the subject security (ies) and issuer(s) and that no part of his (their) compensation was, is or will be

directly or indirectly related to the specific recommendation(s) or views contained in this research report.

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Stock Ratings Absolute Returns Buy : > 15% Hold : 5 - 15% Sell : < 5%