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Reduce Escorts, target Rs 435: Reliance Securities

Escorts is a midcap company, operating in auto sector.

Last Updated: Jul 30, 2019, 01.45 PM IST
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The brokerage has set a one-year horizon for the stock to hit the target price.
Reliance Securities has given a 'reduce' recommendation on Escorts with a target price of Rs 435.

Shares of Escorts traded at Rs 472.3 around 1:25 pm on 30 July, 2019. The brokerage has set a one-year horizon for the stock to hit the target price.

"Escorts (ESC) missed our estimates albeit marginally in Q1FY20 owing to lower operating margin and higher interest outgo," said the brokerage.

Its revenue, Ebidta and adjusted PAT fell by 6 per cent YoY (down 13 per cent QoQ), 23 per cent YoY (down 25 per cent QoQ) and 27 per cent YoY (down 28 per cent QoQ) to Rs 1,420 crore, Rs 140 crore and Rs 87.5 crore aginst the brokerage's estimate of Rs 1,390 crore, Rs 140 crore and Rs 91.1 crore, respectively.

Its Ebidta margin fell by 227bps YoY and 162bps QoQ to 10 per cent (against the brokerage's estimate of 10.3 per cent), mainly due to lower operating leverage.

Its tractor volume fell by 14 per cent YoY, while construction equipment volume plunged by 21 per cent YoY. Its railway segment’s revenue rose by a strong 34 per cent YoY.

Its RM/sales increased by 137bps YoY (up 18bps QoQ) to 69 per cent, while other expenses/sales increased by 30bps YoY and 6bps QoQ to 12.4 per cent.

Its Ebit margin stood at 10.9 per cent and 20 per cent for agri business and railway business, respectively. Following a spectacular performance over the last three years, the domestic tractor industry started witnessing moderation since the beginning of FY20, which the brokerage expects to undergo a cyclical downturn over FY20-FY21E.

Despite likely pick-up in construction activity, major buying decision of tractor is driven by agri-based requirements.

Delayed monsoon, higher deficit in few regions, lower water level at reservoirs and high YoY base are the key hurdles for the industry over the medium-term.

Though few issues may get resolved partially or fully with which the industry decline may taper down, the impact of cyclical downturn is inevitable.

"We believe that these factors would impact the tractor volume across regions barring few geographies of north and central," said the brokerage.

Non-agri usage of tractors would not be sufficient to compensate the expected fall in agri-driven demand. Similar downturn in the construction equipment sector is also expected.

"We reduce our volume growth estimate for FY20E/FY21E. Our channel check indicates incremental discount by most players to chase market share in subdued industry scenario, which would increase margin pressure for Escorts," said the brokerage.

Outlook and valuation
The brokerage expects ESC’s tractor volume to fall by 8 per cent and 6 per cent YoY in FY20E and FY21E, respectively.

It had reduced its construction equipment volume estimate by 17 per cent and 19 per cent for FY20E and FY21E, respectively and lowered its revenue and Ebidta estimates by 12 per cent and 11 per cent and 19 per cent and 19 per cent for FY20E and FY21E, respectively.

"We cut our EPS estimates by 18 per cent and 21 per cent for FY20E and FY21E. In view of expected cyclical down-turn and declining return ratio, we would assign down-cycle P/E multiple to Escorts, hence we lower our target P/E valuation multiple from 11.5 times to 10.5 times 1-Year forward," said the brokerage.

Moreover, poor visibility on tractor industry’s volume over the next 2-3 quarters strengthens the case for valuation downgrade.

"We reiterate our reduce recommendation on the stock with a revised target price of Rs 435 (from Rs 600 earlier), valuing it at 10.5 times FY21E EPS," said the brokerage.

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