VST Tiller Ltd
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Transcript of VST Tiller Ltd
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VST Tillers Tractors Ltd
Buy Rs.900/- and hold for 5 years. 15th Apr, 2014
Increasing productivity is the key to Indias food security
Farm mechanization sector to gain from structural up-cycle...
The value of agriculture in India can hardly be overemphasized.
While its share in GDP has come down over the years, agriculture continues to employ
the largest chunk of Indian population. The industry has seen massive change over the
years- vast chunks of land getting fragmented, shift from human and animal power to
the use of farm machinery, migration from rural to urban areas etc.
Amid the challenges like high dependence on monsoons and shrinking land and labor
supply, the need for food to feed India's ever-growing population has gone up. Further
thrust on food security and on getting more area under irrigation, improvement in the
logistics and increase in the minimum support prices suggest that a lot more can be
expected from this sector in the years to come.
Keeping in mind the challenge s that the sector is facing, there is only one way to meet
the demand for increased farm product. That is, to improve farm yield (output
production per hectare) from the limited assets. And this explains the huge scope ahead
for farm mechanization. The same is likely to lead to faster turnaround of farm work,
multi cropping and higher yields, despite shrinking resources.
Following factors are likely to support the trend further:
Shortage of labor supply in agriculture due to urban migration and rural
employment guarantee
Rising wage pressure and increasing costs of using animal power.
Favorable financing environment for farm machinery (for. e.g. tractor loans
qualify as priority sector lending and are less likely to go bad) and rising
penetration of the private sector lenders in this space
Rise in minimum support prices.
Farm subsidies, subsidy on the sale of farm equipments (e.g. subsidy on tillers) .
Increase in farm exports.
And, low penetration in most of the Indian states (as far as use of farm power per
hectare is concerned).
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One should note that while the land available for farming has remained almost
constant, the land holdings over a period of time have been getting smaller. Around
80% of the farms in India are small and marginal. This I believe will boost the demand
of machinery that is relatively scale neutral (such as use of low Horse Power tractors).
As such, there is a lot of ground to cover with regards to first time users. Also, once the
demand is created, it is likely to stay. This is because as a farmer moves up in the
technology; he is unlikely switch back to conventional ways of farming. Multiple uses of
farm equipments (like tractors) for off farm work such as transportation and
construction are likely to support the demand. Even in the case of smaller land holdings,
the demand is likely to be robust due to the trend of custom hiring. Hence, in the long
term, the penetration of farm machinery in India is likely to rise and firms catering to
the same have huge scope to grow.
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About VST Tillers Tractors Ltd
VST Tillers Tractors Ltd (VTTL) is in the business of manufacturing and sale of farm
equipments such as power tillers and small tractors. Besides this, the company is also in
the trading business of farm equipments such as rice transplanters, harvesters, front end
loaders etc. It also manufactures diesel engines and precision components for captive
use as well as for sales. The company was incorporated in the year 1967 in Bangalore,
India. The company is promoted by the V.S.T Group, a well known business house in
South India. It started with technical collaboration and joint venture with Mitsubishi
Heavy Industries and Mitsubishi Corporation, Japan for the manufacture of power tillers
and diesel engines. In 1984, the company entered into an additional technical and
financial collaboration with Mitsubishi Agricultural Machinery Company Ltd, Japan to
introduce small tractors (18.5 HP and 4 wheel drive).
The company has its manufacturing plant located in Whitefield Industrial area near
Bangalore a combined capacity of over 30,000 power tillers and small tractors. Towards
the end of March 2014, the company commissioned its new tractor plant at Hosur. The
plant has been funded largely through internal accruals and it will have a capacity of
producing 36,000 tractors per annum.
The main products of the Company namely Power Tillers and Tractors are used in the
agricultural sector all over the India. Power Tillers and Tractors are exported to whole of
Africa. The Tractors are also exported to Middle East, Russia and Turkey. The
component parts are exported to Europe, Korea and Thailand.
The company has a nation-wide presence through its dealers. It is known for its after
sales support and services. The company has taken various steps towards increasing
customer satisfaction such as on-time supply of spare parts, provision of service tools
and equipments, making available service information through technical literature,
instruction manuals etc., and imparting training to end users namely the farmers.
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Key Management Personnel
Mr. V.P. Mahendra, is the Chief Executive Officer of VST Tillers Tractors Limited and
has been serving as a Managing Director of the Company since 1989. He has also served
as a Non-Executive Director with Kirloskar Electric Co and Cholamandalam Investment
& Finance Co. in the past. He is a graduate in engineering from the University College
of Engineering, Bengaluru.
Mr. R Thiyagarajan is the Vice President and Chief Financial Officer, of the company.
He is a Chartered Accountant by qualification
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Geared for higher growth, better cash flows and margins...
The changing business mix with a greater focus on tractors makes this company a
compelling investment even now...
Do you often find yourself looking for that perfect investment idea? Where do you look
for that perfect idea? It is observed that many investors tend to ignore their existing
investments and look for the proverbial newer, greener pastures. Is this always the best
thing to do?
Who would be a better person to answer this than Peter Lynch, one of the most
successful money managers ever? Let us tell you that during the thirteen years (1977 to
1990) when he ran the Fidelity Magellan Fund he outperformed the market by a
whopping margin, delivering average annual returns of over 29%. One of his key
investing principles was this: "The best stock to buy may be the one you already own. "
In fact, many of the minor purchases by the Magellan Fund later went on to become
major holdings. Here is one simple truth that all investors must remember. The number
of great businesses is limited. Instead of looking for newer investments ideas, why not
buy more of an existing investment that still has great future potential.
The company has been in the business of manufacturing and marketing of power tillers
and tractors. Over the last nine years, the share of power tillers to the overall revenue
has been, on an average, about 61%. However, recent trends in the business mix suggest
that the share of tractors is on the rise.
The managements focus can be ascertained from the fact that towards the end of March
2014, the company commissioned its new tractor plant at Hosur. This plant, which has
been funded largely through internal accruals (Rs 700 m), will have a capacity of
producing 36,000 tractors per annum. This is indeed a very significant move. While in
FY13, the company sold 6,233 units, the volumes for FY14 are expected to be in the
range of 7,300 to 7,500 units (During 9MFY14, company has sold 5,545 units). Now, with
the new capacity coming in, the volume growth in this line of business is expected to
remain very strong. In the overall domestic tractor industry, VST has a market share of
around just 1%. As such, the overall build up in capacity is not expected to impact the
sector significantly.
Moreover, what makes VST stand apart from the rest is its focus on a niche segment of
the industry the sub-20 HP (horse power) segment, where in farmers having smaller
land parcels are targeted as prospective customers.
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VST continues to have a strong hold in the western regions, and is also looking to
expand its reach in other states as well. Also, the company has indicated that it would be
launching certain models in the 20+ HP segments.
With the contribution from the tractor business rising, the dependence on the traditional
power tillers business will reduce as a proportion of the total revenues. The latter is a
segment that is marked by high competition (especially from low cost Chinese products)
as well as issues related to delayed subsidy payments by the government. I believe that a
greater contribution from the tractor segment will improve VSTs cash flow generation
as well as margin profile.
Factors such as burgeoning farm labor costs, rising food demand and the consequent
demand for higher productivity point at a structural change towards farm
mechanization. And here we have a great business with a proven track record, solid
financial health and a compelling future growth strategy. It stands to benefit
tremendously from the structural changes in the agriculture sector.
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How VST Tillers Tractors Ltd will improve its fortunes
Farm mechanization to help growth momentum
The Indian government is concerned about the food security. It has set an
ambitious target of 4% agricultural growth for the 12th 5-year plan (2012-17). A
large part of this focus is on increasing productivity. However, due to
industrialization, farmland area is contracting with each passing year. At the
same time, people are migrating from the rural areas to urban cities. This is
creating a shortage of labor in the farmlands. All this is hindering the growth of
agricultural production in the country. Only way forward is farm mechanization
which helps to increase the productivity of farmlands. The use of farm
equipments such as power tillers, tractors etc are ways to go for farm
mechanization.
Therefore, farm mechanization would remain as a focus area for the government
in the foreseeable future. The central and state governments have allocated a
subsidy scheme of Rs 45,000 to 60,000 for power tillers. In addition to this farmers
also get loans at subsidized rates due to governments focus on priority sector
lending. Besides this, the government is gradually increasing minimum support
price of agricultural produce. As a result, income levels of farmers have been on
the rise which would put them in a better position to buy farm equipments. All
this would help increase the market for farm equipments like tillers. VTTL has a
strong presence in this segment and is well poised to reap the benefits from this
growing opportunity.
Strong presence in farm equipment markets
VTTL is the market leader in the power tiller segment business. The company
commands around 40% to 45% share of the total market. Despite presence of
cheaper Chinese products, the company has done well to maintain market share.
The products of VTTL are superior in terms of quality and are believed to last for
about fifteen-twenty years.
In the past, the company had introduced one more farm equipment - Paddy
Translators. This product has not witnessed much success so far. However, this
product also holds a good future prospect in light of growing labor shortage.
Leading position in power tillers segment and long experience in the farm
equipment area would help the company continue to grow in the future.
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After sales service is the key
Besides having quality products, VTTL has a nation-wide presence through its
extensive dealer network. As a result, the company is well positioned to exploit
the growing potential of farm equipment market. However, key to success lies in
the after sales service. Auto equipments need constant servicing to run properly.
With wider presence, the company is able to cater to the needs such as spare-part
replacement as well as servicing. This leads to higher customer satisfaction.
Needless to say, this would help the company to maintain its market leadership
position and grow well in the future.
This also helps the company dominate in the market despite the presence of
Chinese products at lower prices. Chinese products particularly lack in the area of
after sales service.
Robust financial health
For the past five years, VTTL has witnessed a stellar performance at both top line
as well as bottom-line levels. During this period, revenues and net profits of the
company grew at an average rate of 21% and 28% respectively on compounded
annual growth rate basis. As compared to earlier periods, FY13 was a tough year
for the company on account of various factors such as the poor monsoons, higher
interest rates and supply chain issues. The companys operating margins have
however been on the rise, as the contributions from the tractor segment have
been increasing. With the same likely to continue in the future, I expect the
companys margins to remain above the long to medium term average margins.
Coming to the balance sheet, the same has been clean with minimal debt on
books. This has been the case for many years now. In FY13, the company had not
debt on books. When it comes to managing the working capital, the same has
risen in the past two years, largely due to higher amount blocked in receivables.
But if we see a longer term horizon, it has averaged to about 18% (non cash
working capital) of sales over the past eight years. Further, the company has been
consistently rewarding shareholders. The dividend payout averaged to 16% over
the past five years (16% in FY13 as well). The average return on equity has also
stayed above 30% over the past five years.
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Key challenges for VST Tillers Tractors Ltd
Not much control on pricing and receivables
At present, the business of power tillers in India runs on the subsidy support
given by the government. A central subsidy of Rs 45,000 on power tillers is
administered through the states. Many states top it up with additional state
subsidy ranging from Rs 10,000 to Rs 15,000. The practice in the state is that the
subsidy is paid to the company or its authorized dealers. This leads to higher
delays in receiving payments - which could range from 60 to 180 days that is
paid to the manufacturers such as VTTL.
Further, the prices are also to be authorized by all the states once a year. The
company has to maintain the decided price irrespective of any increase in input
prices. This poses a threat for the profitability of the tiller business.
Rising competition in the tiller and tractor segments
While the company has been facing issues related to cheaper import of tillers for
a while now, which it has done well to control, one cannot ignore the possibility of
the scenario worsening from here on. Imported power tillers from China- the
largest producer of power tillers in the world are also eligible for subsidies.
Such tillers form near 30% of the overall market. But while they have the cost
advantage against the domestic manufacturers such as VTTL, the latter have an
edge in terms of quality and service (as mentioned earlier in this report) which
are aspects that mitigate such a risk.
In the tractor space, given that the niche sub 20 HP segment has been growing
fact, it has attracted competition from competitors. For example, Mahindra &
Mahindra had launched its small tractor under brand name Yuvraj. Other
players have also entered this segment in recent times. While VTTL continues to
enjoy the first mover advantage and a strong brand name in the space it operates,
one cannot ignore the risks from competition.
Poor monsoon season
Given that VTTLs business is directly dependent on the agriculture, one cannot
ignore the possibility of poor monsoon season impacting the sales volumes of the
company. With increasing threats of the El Nio impacting the monsoons this
year, this would be a big concern for the company.
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End of subsidy scheme
As mentioned earlier, the business is run on the support of government subsidy
scheme. Therefore growth of the market depends on the growth of subsidy. In the
worst case scenario, at some point if the government decides to end the subsidy
scheme; the business of the company will be adversely impacted. But looking at
the government focus on agriculture in the 12th five year plan, this situation is
very unlikely.
Interestingly, the management of the company finds this adverse situation a good
opportunity. According to them, the business may suffer for short term. But after
that, when markets stabilize, the company would be able to control the pricing
better.
Risky small caps
It is important to note that small caps are inherently more risky as compared to
the blue-chip or mid cap stocks. That is the reason we do not recommend small
caps to those having a low risk profile. Even for investors having an appetite for
slightly more risk, it is advisable to invest not more than 15% of one's portfolio in
small-cap stocks.
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Risk Analysis
Regulatory Risk
Some businesses are subject to regulations by external government agencies.
These companies are subject to regulatory risk since they do not have the liberty
to operate in a free environment. Excessive regulations can create bureaucratic
hassles and impede growth. Thus, higher the regulation, higher is the risk for any
business. The tiller business in India is one that faces regulatory risks in the form
of subsidies and limited pricing ability of the tiller manufacturers. Not to
mention the issues related to the delay in payments on account of the same.
However, with the contribution from the tractor business on the rise, this risk is
curbed to some extent.
Cyclicality Risk
A business cycle is characterized by alternating periods of expansion and
contraction. Businesses whose fortunes typically swing with industry cycles are
known as cyclical businesses. Cyclical businesses do well during an industry
upturn and vice versa. On the other hand, there are some businesses that are not
very cyclical. These businesses are more immune to changes in industry cycles in
the sector and have less risk. In short, if the business is cyclical, the risk is higher.
Given that the tractor and power tiller business is dependent on the agricultural
sector, which in turn relies on monsoons, in addition to other factors such as
interest rates and credit availability.
Competition Risk
Every industry is characterized by competition. However, some industries where
entry and exit barriers are typically low have higher competition risk. Low
barriers means more players can enter into the industry thereby intensifying
competition. While the competition in the power tiller and tractor segment is
significant, VST does stand out on account of strong market share in the
segments in which it operates.
Sales Growth
Over the ten year period (actual history of past 5 years and explicit forecast for
the next 5 years) I expect sales CAGR of around 22.9%.
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Net Profit Growth
Over the ten year period (actual history of past 5 years and explicit forecast for
the next 5 years) I expect a net profit CAGR of around 28%.
Operating Margin
The operating margin is a measurement of what proportion of a company's
revenue is left over after paying for variable costs of production such as raw
materials, wages, and sales and marketing costs. A healthy operating margin is
required for a company to be able to pay for its fixed costs, such as interest on
debt. The higher the margin, the better it is for the company as it indicates its
operating efficiency. VST's average operating margin over the ten year period
(actual history of past 5 years and explicit forecast for the next 5 years) stands at
16.6%, which is moderate.
Net Margin
The net margin is a measurement of what proportion of a company's revenue is
left over after paying for all the variable and fixed costs inclusive of interest and
depreciation charges. Net margin is the final measure of profitability. It reflects
the total profits the company takes home. Higher the margin, better it is for the
company as it indicates better pricing power and effective cost management. For
VST, the average net margin over the ten year period (actual history of past 5
years and explicit forecast for the next 5 years) stands at 11.1%.
Return on Net Worth (RoNW)
RoNW is an important tool to assess a company's potential to be a quality
investment by determining how well the management is able to allocate capital
into its operations for future growth. RoNW of above 15% is considered decent for
companies that are in an expansionary phase. The average RoNW over the ten
year period (actual history of past 5 years and explicit forecast for the next 5
years) for the company stands at 28.8%, which is good.
Earnings quality
This measure helps us assess the quality of earnings reported by the company.
For instance, some companies may follow aggressive accounting practices and
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recognize revenues earlier than warranted. Earlier recognition of revenues boosts
profits. However, at the same time they do not generate sufficient operating cash
flow (OCF). This signifies debtors are not liquidated on time as sales were booked
in advance. Such companies face working capital issues and their quality of
earnings is poor. We assess earnings quality by dividing operating cash flow to net
profits. Higher the ratio better is the quality of earnings. For VST the average
OCF/net profit ratio over the ten year period (actual history of past 5 years and
explicit forecast for the next 5 years) stands at 0.6 which is healthy.
Transparency
Transparency is the key to any business. Transparency can be gauged by
assessing the past dealings of the company with various stakeholders, the way it
displays its financial information and the frequency of management's desire to
communicate with external shareholders whenever some unfortunate incident
happens. The easiest way to gauge the same is checking the level of disclosures in
the company's quarterly financial updates and annual reports. Transparent
managements would get a higher rating. In our view, the company's level of
disclosures is not up to the mark, as per industry standards
Capital allocation
Apart from transparency, capital allocation skills are equally important in
assessing management quality. By capital allocation we mean how the
management chooses to deploy capital in the business. There are many instances
where growth is given priority over returns on the investment. This results in a
company with larger size but with poor returns. Managements are enticed to
increase the size since their compensation is tied to the size of organization they
manage. Also, they sometimes destroy shareholder wealth by making expensive
acquisitions or by diversifying into unrelated areas. Hence, capital allocation
skills assume great importance in gauging management quality. Capital
allocation skills are good when return ratios depict resilience. In short, more
stable/higher the return ratios better the capital allocation skills. VST's return
ratios and the managements capital allocation decisions over the years have been
reasonably good.
Promoter pledging
Promoters typically pledge their shares to take a loan which is generally infused
in the company. This exercise is generally resorted to when all other sources of
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external liquidity dry out. The risk with this strategy arises when share price falls.
This triggers margin calls. If management is unable to provide some sort of a
collateral to the lending party from whom the money is borrowed that party may
sell the shares to recover its money. This accentuates the share price fall. Hence,
higher the promoter pledging higher is the risk. With none of the promoter
equity being pledged..
Debt to equity ratio
A highly leveraged business is the first to get hit during times of economic
downturn, as companies have to consistently pay interest costs, despite lower
profitability. We believe that a debt to equity ratio of greater than 1 is a high-risk
proposition. The D/E ratio for VST over the last five years has stayed low. In fact,
the company became completely debt-free in FY13. The average D/E ratio over
the ten year period (actual history of past 5 years and explicit forecast for the next
5 years) stands at 0.03 times.
Interest coverage ratio
The interest coverage ratio is used to determine how comfortably a company is
placed in terms of payment of interest on outstanding debt. It is calculated by
dividing a company's earnings before interest and taxes (EBIT) by its interest
expense for a given period. The lower the ratio, the greater are the risks. Given
the low debt levels and strong cash flows of VST.
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Finance at a Glance
Standalone (Rs. M) FY13 FY14E FY15E FY16E FY17E FY18E
Sales 4817 6129 8072 9935 12162 14830
Sales Growth (%) -9.20% 27.20% 31.70% 23.10% 22.40% 21.90%
Operating Profit 722 1128 1372 1699 2110 2572
Operating Profit margin (%) 15.00% 18.40% 17.00% 17.10% 17.40% 17.30%
Net Profit 483 742 896 1116 1393 1706
Net Profit margin (%) 10.00% 12.10% 11.10% 11.20% 11.50% 11.50%
Balance Sheet FY13 FY14E FY15E FY16E FY17E FY18E
Current Assets 2358 2830 3700 4853 6193 7911
Fixed Assets 915 1271 1357 1437 1512 1582
Investments 42 42 42 42 42 42
Other assets 44 44 44 44 44 44
Total Assets 3358 4186 5142 6376 7791 9578
Current Liabilities 682 906 1134 1460 1743 2143
Net Worth 2444 3047 3775 4683 5815 7202
Loan Funds 0 0 0 0 0 0
Other Liabilities 233 233 233 233 233 233
Total Liabilities 3358 4186 5142 6376 7791 9578
Valuation FY13 FY14E FY15E FY16E FY17E FY18E
Revenue (Rs. m) 4817 6129 8072 9935 12162 14830
PAT (Rs. m) 483 742 896 1116 1393 1706
EPS (Rs.) 55.9 85.8 103.8 129.2 161.3 197.4
Price to Earnings (x) 17.8 11.6 9.6 7.7 6.2 5.1
Price to Sales (x) 1.8 1.4 1.1 0.9 0.7 0.6
Price to Book value (x) 3.5 2.8 2.3 1.8 1.5 1.2
Comparative Valuations
Parameters VST Tillers Tractors Ltd Escorts Ltd Swaraj Engines
Year - End Mar-13 Spe-12 Mar-13
Net Sales (Rs. m) 4817 38939 4790
EBITDA margin (%) 15.40% 5.80% 16.10%
Net margin (%) 10.10% 1.70% 10.30%
ROCE (%) 30.60% 8.70% 41.90%
Debt / Equity (x) - 40.00% -
TTM P/E (x) 11.70 8.90 13.30
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Why is the stock worthy of investment?
A strong focus and a proven capability in tiller manufacturing, an impressive track
record, strong financials and a shareholder-friendly management make VST Tillers Ltd
a good long term investment. The company's products are well-accepted in the country
and its recent foray into tractor manufacturing is a huge positive.
VST Tillers has been able to grow its revenues and profits at a compounded annual
growth rate (CAGR) of around 21% and 28% respectively over the last five years. The
company generates strong cash flows and the return on invested capital (RoIC) has
averaged an impressive 25% during the same period. All this while, the company has
hardly required any debt to fund its growth.
For long term target expecting Rs.3,300/- and Rs.5,600/-