Escorts Ltd (ESC) Sector: Commercial Vehicles/Midcap

Initiating Coverage 14 October 2014 Sensex Nifty Price: INR 163 Target Price: INR 188 OUTPERFORMER 26,349 7,864 Background : Escorts Ltd (ESC) is one of India’s prominent players in the Automotive / Tractor industry, with an overall market share of ~11% in the domestic tractor industry. ESC is also present in construction and material handling equipment, such as cranes, compactors and forklifts with 55% market share in material handling segment. ESC has also forayed into Auto Ancillary and Railway division which are still at a nascent stage. Key customers in the auto parts include Yamaha, Suzuki, Piaggio & TVS. . 52 Week Low/High INR 81/167 Exiting <30HP segment to increase profitability . Bloomberg code ESC IN ESC witnessed a decline in its market share from ~11.7% in FY11 to 10.7% in FY14. The loss in market share Reuters code ESCO. BO was primarily attributable to ESC exiting the lower i.e <30 horse power (HP) market segment due to lower Issued Equity 122.6 margins in that segment and a greater reliance on Government subsidy in that segment. Gross margins of <30 (shares in mn) HP segment are ~ 20% as compared to ~30% gross margins in the higher HP segment. Consequently ESC Mkt. Cap in mn INR 19984 has increased its focus in higher HP segment both in 45-50HP segment and 50HP+ segment. We expect ESC Mkt. Cap in mn USD $ 326.5 to gain market share in the 45-50HP segment with the help of new product launches and the increased Avg. Daily Vol. (‘000) 2874 traction in 50HP+ segment. Avg. Daily Vol. (mn) INR 445/$7.3 New product launches, focus on South markets to regain market share in 45-50 HP. ESC’s market share in the 45-50HP (which is a significantly large segment contributing ~ 28% of the industry), Shareholding Jun13 Mar14 Jun14 has declined primarily due to ESC’s miniscule presence in the South Market. ESC is gradually setting up more dealerships in South; ~ 85% of the 150 dealers added in the last year are in South Market. It is already in Promoters(%) 41.98 41.97 41.96 FII (%) 12.08 6.88 5.20 advanced stages to launch a new 50HP tractor to improve its position in the black cotton soil areas of Maharashtra, Karnataka and AP. ESC is witnessing increase in traction in south markets. We estimate ESC’s DII (%) 5.38 2.19 4.03 market share trend in the 40-50HP segment to reverse and witness an increase by 110bps to ~12% in FY16E Others (%) 40.56 48.96 48.81

Pledge (% of Cost reduction, VRS schemes, and better product mix to aid margin expansion: promoter 0.00 0.00 0.00 ESC’s presence in <30HP segment, which returns lower gross margins of ~20% and high employee cost and holding) lower operating leverage affected EBITDA margins unfavorably. In the wake of this ESC has taken steps to increase their margins: 1. Vacating <30HP category- better product mix would yield higher margins as higher HP tractors have Performance% 1M 3M 12M a higher product realization and higher gross margins ESC 36.5 14.9 85.1 2. Has undertaken cost reduction measures in a bid to reduce material costs. Management guided for Sensex 0.14 6.12 37.24 a 2% reduction in material cost by FY16E.

3. Has issued VRS schemes in a bid to reduce high employee costs. Management guided for a 3% 180 180 reduction in employee costs (EAM) after the end of this scheme.

160 160 Auto ancillary and construction segments are expected to break even by 4QFY15. We have estimated the EBITDA margins to increase by 175 bps over FY14E to 7.7% in FY16E. 140 140

120 120 Valuation: At the current market price ESC is trading at a P/E of 12.1X and 8.6X its FY15E and FY16E

100 100 earnings respectively. We assign a target P/E of 10.0X to its FY16E EPS to arrive at a target price of INR188 and assign an OUTPERFORMER rating. We believe the valuation is justified given the low debt, breakeven in 80 80 new segments and improvement in ROE. Risks: Delay in turnaround in new verticals and infrastructure 60 60 spending, delay in agriculture subsidies by the Government, unfavorable monsoons affecting farm income 40 40 levels, and adverse raw material price movements.

20 20 Valuation Summary 0 0

Y/E March ( INR mn) SEP12 Mar14* FY15E FY16E

13 14

13 14 14

- -

- - -

- Revenue 40,495 65,017 46,120 52,116

Jul

Jan

Mar

Sep Sep Nov May EBIDTA 1895 3870 3090 4013 ESC Relative Index (RHS) Adj.PAT 738 2467 1584 2247 Adj.EPS 6.2 20.7 13.3 18.8 Adj. EPS growth (%) -55 NA NA 42 Analyst: PE ` 26.1 7.8 12.1 8.6 P/ BV 1.2 1.0 1.0 0.9

Murugesa S +91-44-30007363 EV / Sales 0.7 0.4 0.5 0.4 [email protected]. com EV / EBIDTA 13.9 6.3 7.7 5.7 Dividend Yield (%) 0.8 0.4 1.3 1.8 ROCE (%) 7.2 13.9 9.6 12.7 ROE (%) 4.4 13.2 8.0 10.3 Debt / Equity 0.3 0.20 0.17 0.13 *18 months ending March 2014

Company Profile:

Escorts Ltd (ESC) is one of India’s leading players in the Automotive / Tractor industry, with an overall market share of 10.7% in the domestic tractor industry. ESC is also present in construction and material handling equipment, such as cranes, compactors and forklifts with 55% market share in material handling segment. ESC has also forayed into Auto Ancillary and Railway division which are still at a nascent stage. Key customers in the auto parts include Yamaha, Suzuki, Piaggio & TVS.

Corporate-History:

•Pioneered farm mechanization with a franchise from the U.S. based Minneapolis Moline, for marketing 1948 tractors, implements, engines & other farm equipment.

1949 •Franchise of Massey Ferguson tractors for northern India.

•Collaboration with Mahle of Germany to manufacture pistons. Soon, Escorts became the largest 1959 producer of piston assemblies in India.

•Setting up of manufacturing base at Faridabad for manufacture of tractors in collaboration with URSUS 1961 of Poland and 50% indigenous components.

•Escorts Tractors Limited was born. A technical and financial joint venture with the global giant Ford 1969 Motor Company, USA, to manufacture Ford tractors in India.

•Collaboration with JCB Excavators Ltd., UK for manufacture of excavators. 1979

•Joint Venture with Claas of Germany to manufacture harvester combines 1989

•POWERTRAC series of tractors launched. MoU was signed with Long Manufacturing Company, USA for 1998 setting up a Joint Venture in USA.

•ESC launches Fully Hydraulic Crawler Cranes 2008

•ESC commissions state-of-art manufacturing plant for pick-n-carry cranes and vibratory compactors 2009

Exhibit 1: Business snapshot: Business Revenue share Divisions in FY14 (%) Products offered Competitors

Agri Machinery Tractors, tillers, harrow, ploughs, bailer, crop solutions, Mahindra & Mahindra, TAFE, group 81 engine gensets John Deere, Sonalika Shock absorbers, telescopic front forks, McPherson struts, Minda Industries, Munjal Auto Products 3 steering components, special dampers Showa

Railway 4 Brake systems, couplers, suspension system, composition products material, vestibule, green toilets, testing equipment Rail Udyog Leyland Deere, Caterpillar, Construction Material handling equipment, earth moving equipment, Greaves cotton, Ace equipment 12 road construction equipment, utility equipment equipments

Exhibit 2: Corporate Structure: ESC has 4 subsidiaries and 1 joint venture: Name of the company Country of Proportion of ownership Held by incorporation (%) Farmtrac Tractors Europe Sp. z.o.o Poland 100 Escorts Limited Escorts Securities Ltd. (ESL) (Board Controlled) India 49 EAML Escorts Asset Management Ltd. (EAML)(Board Controlled) India 30 Escorts Limited EDDAL Credit Limited India 99.86 Escorts Limited

Hughes Communications India Limited (JV) India 13.38 Escorts Limited Source: CSEC Research

Exhibit 3: Escorts markets its tractors under two brands namely, ‘Farmtrac’, ‘Powertrac’; ‘Ferrari’ tractors launched recently- Tractors contribute ~72% of ESC revenues Brand HP Range Segment Price- INR mn Share of volumes Powertrac 34-55 Economy 0.29-0.47 50% Farmtrac 34-75 Premium 0.32-0.55 50% Ferrari 25-35 0.26 100 units (new) Source: CSEC Research

Exhibit 4: Manufacturing facilities PARTICULARS No. of plants CAPACITY 4 100,000 tractors p.a Agri Equipment 1 (100% subsidiary Poland) 2500 tractors p.a Construction equipment 1 14000 units p.a Couplers- 1100 pa 1 Air Brakes- 1400 pa Escorts Railway Products Brake blocks- 32000 pa

1 3.2mn shock absorbers Escorts Auto Product 0.3 mn front forks Source: CSEC Research

Exhibit 5: Management Team

Mr. Rajan Nanda- Chairman & Managing Director

• Mr. Rajan Nanda is Chairman of the Board, Managing Director of Escorts Limited. He is no longer a Managing Director of the

Company effective September 18, 2013. He is an alumnus of Doon School, Dehradun. He took over as Chairman of Escorts

Group in the year 1994. As member of the CII National Council he has served as Chairman of its Agriculture Committee in the

past years.

Mr. Nikhil Nanda - Managing Director

• Mr. Nikhil Nanda is Managing Director, Executive Non-Independent Director of Escorts Limited. He has been appointed as

Managing Director of the Company effective September 18, 2013. Prior to joining the Company, Mr. Nikhil Nanda has worked

as Joint Managing Director of Escorts Yamaha Motors Limited during the period 1997 to 2000. As JMD he is responsible for

business diversification, business process re-engineering, organisational development in the Company. He is a Graduate of

Wharton School of Management, USA.

Mr. S Sridhar- CEO Escorts Agri Machinery

• Mr. Sridhar, agriculture engineer, possesses 26 years of rich experience in engineering, automotive industry and

manufacturing. Mr. Sridhar specializes in brand and business strategies. He started his career at Mahindra and Mahindra

Limited’s tractor division and acquired vast experience in TVS Suzuki. He was the former CEO (2 wheeler) and then the

President (motorcycle) of Bajaj Auto Limited.

Exhibit 6: Porter’s Five Force Model

Source: CSEC Research

Industry overview Mid segment- 31-50HP remains the largest segment Tractors are categorized in four different power segments viz., <30HP, 30-40HP, 40-50HP and >50HP with 31-50HP being the largest segment by volumes. Increasing land fragmentation with more nuclear families would call for lower HP tractors (less than 25HP). However, use of higher HP tractors for non-agri purpose viz, haulage, construction purposes has led to higher power tractors (31-50HP) leading to a higher share of bigger tractors. Amidst land fragmentation and lesser incentives in the +50HP category market concentration has increased in the 30-50HP category and in the long term we expect this segment to remain the largest by -volumes.

Exhibit 7: State wise tractor mix

Others 9% Chattisgarh 4% Punjab 5% Karnataka 5% Haryana 6% Bihar 6% AP 7% Gujarat 7% Maharashtra 10% Rajasthan 12% MP 14% UP 15%

0% 2% 4% 6% 8% 10% 12% 14% 16%

Source: CRISIL, CSEC Research

Indian tractor industry is highly fragmented with 93% of the demand coming from 11 major states, of which UP is the largest market. Varying levels of penetration in irrigation & mechanization, incentives by the State Governments has restricted tractor concentration to merely a few states. Though the pan-India tractor penetration at ~20 per 1,000 hectares is high, several states are still under-penetrated. While in mature markets like Haryana, Punjab and Uttar Pradesh, penetration is at 50, 45 and 30, respectively, in all other states, it is below 20 indicating an immense potential to scale up. In Madhya Pradesh, which is now the largest tractor market, penetration is still at 10 tractors per 1,000 hectares. In Rajasthan, Karnataka and Gujarat, tractor penetration is at 12, 12, and 16, respectively, while in West Bengal, Assam and Odisha it is 8, 4 and 10, respectively.

Exhibit 8: Tractor Penetration (per 1000 hectares)

60 50 50 45 40 30 30 20 16 20 12 12 10 8 10 10 4 0 Punjab Haryana Rajasthan Gujarat MP UP West Orissa Karnataka Assam Pan India Bengal

Source: CRISIL, CSEC Research

Growth drivers for the tractor industry Indian tractor industry has been witnessing a healthy growth of ~13% CAGR over FY2004-2014. The major factors contributing to the growth are 1. Labor shortages 2. Minimum Support prices 3. Increasing use of tractors for non agri purposes viz., construction, haulage 4. Increased credit availability

Other factors such as higher yields on par with global standards to cater to the growing population and export opportunities complement the growth prospects of the industry.

Exhibit 9: Paddy Yield (tonnes/hectare) Exhibit 10: Wheat Yield (tonnes/hectare) 8 6.74 7 6 6 5.63 5 5.14 5 5 4 3.17 4 3.59 3.11 2.92 3 3 2 1.77 2 1 1 0 0 China India Russian USA China India Indonesia Bangladesh Vietnam Federation

Source Directorate of economics & statistics CSEC Research Source: Directorate of economics & statistics, CSEC Research

Minimum Support prices negate volatility in farm income: The government of India, through its Minimum Support Prices tries to negate volatility in the farm income. The primary objective of minimum support prices (MSPs) is to ensure remunerative prices to farmers to encourage higher investment and production of agricultural commodities. Every year MSPs for major agricultural products are announced which are fixed after taking into account the recommendations of the Commission for Agricultural Costs and Prices (CACP). MSPs have grown at a CAGR of 10-15 % over the last seven years vis-a-vis 1-5 % growth (CAGR) for the period 2001-02 to 2006-07. The increase in the MSPs has reduced the volatility in farm income over the past few years, even if there were fluctuations in agricultural production due to deviation in rainfall. Exhibit 11: Minimum Support Prices Commodity (INR per quintal) 2010-11 2011-12 2012-13 2013-14 2014-15 Paddy (common) 1000 1080 1250 1310 1360 Jowar (Maldandi) 900 1000 1520 1520 1550 Bajra 880 980 1175 1250 1250 Maize 880 980 1175 1310 1310 Cotton (long staple) 3000 3300 3900 4000 4050 Wheat 1120 1285 1350 1400 NA Source: Farmer Portal, GOI

Tractor penetration in terms of number of units misleading India is estimated to have ~ 4 mn tractors, which in absolute numbers is comparable to other economies in terms of penetration and thus the future potential is expected to be weak. However penetration in terms of horse power (HP) portrays a different picture i.e, the HP of tractors used in India (30-40 HP) and developed countries (>100 HP) differs significantly due to continuous land fragmentation with more nuclear families. Hence, it is more meaningful to compare penetration in HP terms than in terms of number of tractors. The ever increasing fragmentation of land holdings negates

7 the threat posed by the higher penetration in terms of no. of units. The average size of operational holdings in India has fallen steadily from 2.28 hectares in 1970-71 to 1.33 hectares in 2000-01 and 1.16 hectares in 2010-11. The number of land parcels stand at ~ 130mn as against parcels versus 4mn tractors.

Exhibit 12: Land Fragmentation

4% 1%

10%

18%

67%

Marginal <1 ha Small (1-2ha) Semi- Medium (2-4 ha0 Medium (4-10ha) Large (>10 ha)

Source: CRISIL, CSEC Research

Increased credit availability negates limitations from marginal landholdings. Around 85 % of land holdings in India are small and marginal (no. of households holding less than 2 hectare land). Marginal farmers with limited disposable income have been unable to afford tractors in the past. Land fragmentation has thus emerged as the biggest limiting factor for the Indian tractor industry. However, with higher financial penetration in the rural areas due to expansion of NBFCs and banks and increased credit availability, marginal farmers are now able to afford higher HP tractors. Higher realizations due to MSPs and non- farm applications of tractors are also enabling smaller farmers to buy tractors.

Exhibit 13: Increase in farm loans 45 70% 40 66% 61% 63% 65% 35 59% 60% 30 54% 59% 25 55% 20 50% 15 45% 10 5 40% 0 35% 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14

No of small loans financed (mn) % of total loan a/c

Source: CRISIL, CSEC Research

Replacement demand will grow more rapidly in the coming years Replacement period for tractor has come down from 9-12 years earlier to 6-8 years now with the increased application of tractors for non-farm purposes. Currently, non-farm usage accounts for around 30 % of the demand for tractors. Also helped by increased credit availability for used tractors, farmers are shifting away from 31-40HP segment to the 41-50 HP segment. The shift from the 31-40 HP segment to the 41-50 HP segment over the past few years, as discussed earlier, supports this trend.

Exhibit 14: Statewise proportion of commerical usage of tractors

80% 75% 70% 65% 65% 60% 50% 45% 40% 40% 40% 35% 35% 30% 30% 30% 20% 20% 20% 15% 15% 10% 0%

Source: CRISIL, CSEC Research

MNREGA drives rural labor wages: Growing non-farm rural income, on the back of guaranteed employment schemes like MNREGA has discouraged rural youth from working on farms. Rising industrialization and guaranteed employee schemes have consistently driven up the rural wages forcing farmers to resort to increased levels of mechanization. In the past 10 years, farmer’s labor costs have increased more sharply than other input costs, such as seeds, fertilizer or machine labor.

Exhibit 15: Average daily wage rate in rural India

250 204 188 193 200 176 181 165 153 161 150

100

0 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14

Source: CRISIL, CSEC Research

Investment rationale: Conscious decision to increase profitability by sacrificing market share ESC witnessed a decline in its overall market share from ~11.7% in FY11 to 10.7% in FY14. The loss in market share was primarily attributable to ESC exiting the lower i.e >30 HP market segment due to the low margin in that segment amidst greater reliance on Government subsidy in that segment. Gross margins of <30 HP segment are ~ 20% as compared to 30% gross margins in the higher HP segment. Consequently ESC has vacated the <30 HP segment and has increased its focus in higher HP segment both in 45-50HP segment and 50HP+ segment. Thus the loss in overall market share by ESC is misconstrued and is expected to benefit ESC’s profitability. We expect ESC to gain market share in the 45-50HP segment with the help of new product launches and increased traction in 50HP+ segment.

Exhibit 16: ESC segment wise market share movement

30 28 25 20 14.3 15.6 12.6 11.5 10.9 15 9.4 10 6.4 3.4 4 5 0.8 0 0 Upto 30HP 31-40 HP 41-50HP 50HP+

FY10 FY11 FY12 FY13 FY14

Source: CRISIL, CSEC Research

New product launches, focus on South penetration to address loss of market share in 45-50 HP. ESC’s market share in the 45-50HP (which is a significantly large segment contributing ~ 28% of the industry), has declined primarily due to ESC’s miniscule presence in the South Market. Much of the growth in the 45-50HP has happened in the Southern Market, especially Andhra Pradesh whose harder soil conditions are more suited for the 45- 50HP category. On the back of this, ESC has turned its focus on improving its market share in the high growing market - South India, especially Andhra Pradesh. ESC’s current market share in the South region stands at 3.6%. ESC is gradually setting up more dealerships in South; ~ 85% of the 150 dealers added in the last year are in South Market. It is already in advanced stage to launch a new 50HP tractor to improve its position in the black cotton soil areas of Maharashtra, Karnataka and AP. On the back of expansion in dealership, ESC is witnessing increase in traction in South Markets. We estimate ESC’s market share trend in the 40-50HP segment to reverse and witness an increase by 110bps to ~12% in FY16E.

Exhibit 17: ESC region wise market share movement 25 20 18.4 15.6 15 13 10.4 11.2 10 8.3 4.3 3.6 5 0 North South East West

FY10 FY11 FY12 FY13 FY14

Source: CRISIL, CSEC Research

Rising share of higher HP tractors - Positive for Escorts Driven by easier availability of credit and additional ways of monetization of higher HP tractors via, haulage, construction and other non farm use of tractors share of 31- 50 HP tractors, in total industry sales has been increasing steadily since 2003-2004. The mid segment concentrations now stands at 84% in FY14 as against 71% in FY10. The shift away from <30HP segment was also aided by increased tractor penetration in southern & western states, where higher HP tractors are preferred due to harder soil conditions. In addition, the growing share of exports (12%), where > 45 HP tractors dominate (European market starts with a minimum of 45HP) has also contributed to the increasing off take of higher HP tractors. Escorts is vacating <30HP segment and now derives ~98% of its volumes from higher HP tractors (> 30 HP) vis a- vis 88% of the total industry, thereby helping the company to maintain a steady growth trajectory and improve its margins.

Exhibit 18: Tractor HP mix (%)

>51 <30 HP, 10.7 HP, 10.3

31-40 HP, 32.7

41-50 HP, 46.3

Source: CRISIL, CSEC Research

Cost reduction measures, VRS schemes, and better product mix to aid margin expansion: ESC’s EBITDA margin has historically languished around 6% on the back of losses in Auto Ancillary & Construction segment. ESC’s presence in <30HP segment, which returns lower gross margins of 20% also affected margins unfavorably. In the wake of this ESC has taken steps to increase their margins:

1. Vacating <30HP category- better product mix would yield higher margins as higher HP tractors have a higher product realization implying higher gross margins 2. Have undertaken cost reduction measures (employed an external consultant) in a bid to reduce material costs. Management guided for a 2% reduction in material cost by FY16E. We have estimated the material costs to reduce by 130bps over FY14-16E to 70.7% in FY16E. 3. Have issued VRS schemes in a bid to reduce high employee costs. Management guided for a 3% reduction in employee costs after the end of this scheme. We have estimated a 190bps reduction over FY14-16E. Auto ancillary and construction segments are expected to break even by 4QFY15. Also ESC have launched new tractor models (Farmtrac heritage) to penetrate in European market and South African market; export segment with the >50HP tractor returns higher margins at ~11% (as against 8% EBIT margins for domestic segment). We have estimated the EBITDA margins to increase by 175 bps over FY14-16E to 7.7% in FY16E.

Exhibit 19: Exports Nos Exhibit 20: EBITDA Margins 4000 3600 9 3500 8 7 3000 2674 6 2500 2250 1955 5 2000 1679 4 1500 3 909 1000 748 667 2 500 1 0 0 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E Sep-09 Sep-10 Sep-11 Sep-12 Mar-14 FY15E FY16E

Source: Company, CSEC Research Source: Company, CSEC Research

Construction equipment to breakeven in FY15. ESC manufacturers and markets a diverse range of construction and material handling equipment like cranes, loaders, vibratory rollers and forklifts. The company was a pioneer in introducing the concept of Pick 'n' Carry hydraulic mobile cranes in the 1970s in India and continues to be the world's largest manufacturer of these cranes. ESC is the market leader in material handling segment with a dominant market share of 55% in trx cranes. It has gained market share quickly in earth moving segment with the launch of “Digimax” in 2010. ESC’s installed capacity in this segment is 14000 units but they sold only ~ 3200 units in FY14 on the back of a slowdown in construction equipment segment. With new product launches (JV with JCB for road paction equipments) and an anticipated recovery in this segment, we expect construction segment to break even in 4QFY15E (breakeven volume 3600 units). Post a stable government formation at the centre, construction activities are picking up as evidenced by an uptick in GDP in FY14 data. We estimate construction equipment segment to break even in FY15E, as ESC is estimated to sell ~3850 units in FY15E and gradually increase to~ 4200 units in FY16E.

Exhibit 21: Construction equipment nos & EBIT Exhibit 22: Construction GDP (constant prices) 300 7000 251 116000 6244 200 119 6000 114000 5311 112000 100 5000 4569 14 4789 110000 0 4000 108000 -100 3000 106000 104000 -200 2000 102000 -300 1000 100000 98000 -400 -322 0 96000 2009-10 2010-11 2011-12 2014 (18M) Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 EBIT (INR mn) No of units sold Source: CSEC Research Source: Company, CSEC Research

Auto Products- OEM contracts, reduction in employee costs to aid break even ESC Auto Products is the leading manufacturer of auto suspension products including shock absorbers, struts and telescopic front forks. ESC caters to major OEMs like Yamaha, TVS, Suzuki and Piaggio. It also caters to replacement market in India. The company is also engaged in the design and manufacture of specialized dampers and shock absorbers for railway and defense vehicles. However the auto segment has been loss making on the back of legacy issues; ESC’s employee costs for Auto Products division, stand around 33% of the sales. To address this issue the management has offered VRS and expects to reduce employee cost by ~5 PPTs. ESC auto products boast a lower material costs at ~ 70% of the sales as against 75% for competitors. We estimate the auto products segment to break even by 1QFY16E with expected addition to OEMs and uptick in volumes from existing OEM clientele.

Free Cash flow, ROE to improve: ESC’s current agri equipment capacity utilization stands at 69% whilst its construction equipment capacity utilization stands at 20%. ESC has taken measures to improve its tractor manufacturing capacity to 120,000 units by optimizing end to end operations. ESC foresees no additional cap-ex for FY15E & FY16E barring maintenance cap-ex of INR 1bn. Volume off take coupled with minimal cap-ex would enable the company to post higher ROE and positive FCF for FY15 & FY16E. We estimate ESC’s ROE to improve to 10.3% in FY 16E from 4.4% in year ending Sep-12.

PEER COMPARISON

Particulars (FY16E) Escorts M&M TAFE ITL VST Domestic market share- Existing 10.7 41.0 24.8 10.3 1.1 Capacity – Existing 100,000 300,000 200,000 100,000 30,000 Revenue CAGR- Last 5 years 19.9 25.3 15.4 18.5 12 Revenue CAGR- FY14-16E 9.65 11.8 NA NA 17.2 OPM (FY14) 5.8 11.8 14.1 18.3 15.1 Debt- Equity ratio (FY14) 0.24 0.23 0.0 0 0 ROE (FY16E) 10.3 18.35 NA NA 24.55 PE (FY16E) 8.5 12.70 NA NA 12.0 PBV (FY16E) 0.9 2.50 NA NA 2.94 Div Yield (FY16E) 1.7 1.3 NA NA -

Financials & Valuation: ESC is expected to benefit from the huge potential in tractor industry and an expected turnaround in the infrastructure industry. Also, launch of new models for export markets are expected to give a fillip to the revenues. We have estimated revenue CAGR of 9% over FY14-16E with increased traction in agri equipment on the back of anticipated recovery in agri sales, market share gains arising from increased emphasis in southern markets and off take in new verticals.

Exhibit 23: Revenue & PAT 70 4.4 60 3.9 50 3.4 40 2.9 30 20 2.4 10 1.9 0 1.4 Sep-11 Sep-12 Mar-14 FY15 FY16

Revenue PAT Margin

Source: Company, CSEC Research

Valuation: At the current market price ESC is trading at a P/E of 12.1X and 8.6X its FY15E and FY16E earnings respectively. We assign a target P/E of 10.0X to its FY16E EPS to arrive at a target price of INR188 and assign an OUTPERFORMER rating. We believe the valuation is justified given the low debt, breakeven in new segments and ROE reaching industry level.

Exhibit 24: PE Band Chart Exhibit 25: EV/EBITDA Band Chart 300.00 40000.00 35000.00 250.00 30000.00 200.00 25000.00 150.00 20000.00 100.00 15000.00

50.00 10000.00 5000.00 0.00 Oct-09 Oct-10 Oct-11 Oct-12 Oct-13 Oct-14 0.00 Oct-09 Oct-10 Oct-11 Oct-12 Oct-13 Oct-14 Price 6x 8x 10x 12x 4x 6x 8x

Source: ACE Equity, CSEC Research Source: ACE Equity, CSEC Research

Risks:

 Unfavorable monsoons: Excess rains or shortfall in rains adversely affects farm income levels which in turn

disrupts tractor sales.

 Delay in turnaround of verticals: Any delay in turnaround of ESC Auto products and ESC Construction

equipment segment would adversely affect our estimates.

 Delay in agriculture subsidies: Delay/disruption in agriculture subsidies, lowering of MSPs would adversely

affect farm income levels and consequently tractor industry

FINANCIALS

Income Statement (Abstract) Per Share Ratios INR(million) Particulars Sep 12 Mar-14 FY15E FY16E Particulars Sep 12 Mar-14 FY15E FY16E Adjusted EPS (INR) 6.2 20.7 13.3 18.8 Net Revenue 40,495 65,017 46,120 52,116 Cash EPS 4.9 27.2 12.5 19.5 Growth (%) -1 NA NA 13 BV/Share (INR) 137.9 156.4 167.0 182.1 Operating Expenditure 38,599 61,148 43,030 48,103 FCF/Share(INR) -6.0 21.3 6.4 15.2 EBIDTA 1,895 3,870 3,090 4,013 DPS (INR) 1.2 0.6 2.0 2.8 Growth (%) 18 NA NA 30 Depreciation 502 860 893 928 Other Income 483 829 483 483 Key Ratios Interest 970 1,122 650 573 Particulars Sep 12 Mar-14 FY15E FY16E Exceptional Items 14 35 0 0 Tax Paid 187 282 447 749 Dividend Payout (%) 19.9 3.0 15.0 15.0 Reported PAT 738 2467 1584 2247 EBIDTA Margin (%) 4.7 5.9 6.7 7.7 Adjusted PAT 738 2467 1584 2247 PBT Margin (%) 2.3 4.3 4.4 5.8 Growth (%) -42 NA NA 42 RoCE (%) 7.2 13.9 9.6 12.7 RoE (%) 4.4 13.2 8.0 10.3

Current Ratio 0.87 0.97 1.08 1.17

Net Debt Equity ratio 0.31 0.20 0.17 0.13 Balance Sheet (Abstract) Inventory Days 45 31 40 40 INR(million) Debtor days 45 24 38 42 Particulars Sep 12 Mar-14 FY15E FY16E Share Capital 1,201 1,196 1,193 1193 Creditor days 59 37 64 62 Reserves & Surplus 15,254 17,459 18,727 20,526 Interest Cover Ratio 1.9 3.4 4.1 6.2 Networth 16,455 18,655 19,920 21,718 Current Liabilities 15,457 14,223 13,157 14,071 DuPont Analysis Non-Current Liabilities 3,242 2,991 2,991 2,641 Total Liabilities 35,153 35,869 36,068 38,430 Particulars Sep 12 Mar-14 FY15E FY16E Net Fixed Assets 15,948 16,537 16,644 16,717 Net Profit Margin (%) 2 4 3 4 Other Non-Current Asset Turnover 1.1 1.8 1.3 1.4 Assets 5,712 5,484 5,272 5,272 Cash & marketable Leverage factor 1.2 1.2 1.1 1.1 securities 1,452 1,696 1,442 1,880 RoE (%) 4.4 13.2 8.0 10.3 Other Current Assets 12,042 12,152 12,709 14,561 Total Assets 35,153 35,869 36,068 38,430 Valuation Ratios Cash Flow statement (Abstract) Particulars Sep 12 Mar-14 FY15E FY16E INR(million) P/E 26.02 7.78 12.12 8.55 Particulars Sep 12 Mar-14 FY15E FY16E P/BV 1.17 1.03 0.96 0.88 Cash flow from operations 584 3,243 1,494 2,326 EV/Sales 0.7 0.4 0.5 0.4 Cash flow from investing -1,304 -700 -729 -517 EV/EBITDA 13.9 6.3 7.7 5.7 Cash flow from financing -282 -2,299 -1,019 -1,371 Div Yield (%) 0.8 0.4 1.3 1.8 Free cash flow -720 2543 765 1,809 Net change in cash -1,002 244 -254 438

Cholamandalam Securities Limited Member: BSE,NSE,MSE Regd. Office: Dare House,2 (Old) # 234) N.S.C Bose Road, Chennai – 600 001. Website : www.cholawealthdirect.com Email id – [email protected] CIN U65993TN1994PLC028674

Chola Securities is a leading southern India based Stock broker. Our focus area of coverage within the Indian market is Mid and small caps with a focus on companies from southern India.

Our Institutional Equities services are carried out in partnership with RCCR, a boutique Investment research and Corporate Advisory firm founded by a team with extensive experience in the Asset management industry.

RESEARCH Srinivasan V Head of Research* +91-44 - 4505 6003 [email protected] Sathyanarayanan M Consumption +91-44 - 3000 7361 [email protected] Murugesa S Engineering & Cement +91-44 - 3000 7363 [email protected] Michel Charles C Technicals +91-44 - 3000 7353 [email protected] Rajasekhar R IT & Auto Ancillary +91-44 - 3000 7360 [email protected] Karthikeyan P Macro & Financial Services +91-44 - 3000 7344 [email protected] Sreedevi K Associate +91-44 - 3000 7266 [email protected]

INSTITUTIONAL SALES Venkat Chidambaram Head of FII Business & Corporate Finance* +91-44 - 24473310 [email protected] Lakshmanan T S P Chennai +91 - 9840019701 [email protected] Santosh Kumar Sharma Mumbai +022 - 22617210 [email protected]

RETAIL SALES Nikesh AHMEDABAD 079 – 30002968 / 69 [email protected] Sathyanarayana N BANGLORE 080-22211160/61/62/63/64 [email protected] Muthiah A N CHENNAI - HO 044 – 3000 7371 [email protected] Baskaran S CHENNAI - Nungambakkam 044 – 28240052 / 54 [email protected] Saravanan CHENNAI - Adyar 044 - 2452 2111 / 2333 [email protected] A Jaganathan CHENNAI - Ambattur 044-42022155/32571443 [email protected] V Kumar COIMBATORE 0422 - 4292041 / 4204620 [email protected] Maneesh Gupta DELHI 011 - 30461161 / 62 / 63 [email protected] Srinivasa Reddy D V HYDERABAD 040 - 40126821 / 22 [email protected] Sudipta Bhaumik KOLKATA 033 - 44103638 / 39 [email protected] Riken B Mehta MUMBAI 022 - 22617210 / 7203 [email protected] Pravin S MADURAI 0452 - 2601195 / 96 [email protected] Deepak V Kshirsagar PUNE 020 - 30225432 / 33 /34 [email protected] Sivaraman G SALEM 0427-2313226/4040226 [email protected] M N Chandra Sekhar VIZAG 0891 - 6642718 [email protected]

Shakil Ahmed Choudhury Compliance Officer 044 - 30007226 [email protected] *Employees of Business Partner - RCCR DISCLAIMER:

This report is for private circulation and for the personal information of the authorized recipient only, and we are not soliciting any action based upon it. This report is not to be construed as an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. It does not provide individually tailor-made investment advice and has been prepared without regard to any specific investment objectives, financial situation, or any particular needs of any of the persons who receive it.

The research analyst who is primarily responsible for this report certifies that: (1) all of the views expressed in this report accurately reflect his or her personal opinions about any and all of the subject securities or issuers; and (2) no part of any of the research analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this report. This report has been prepared on the basis of information that is already available in publicly accessible media or developed through analysis of Cholamandalam Securities Limited makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete.

The views expressed are those of the analyst and the Company may or may not subscribe to all the views expressed therein Cholamandalam Securities Limited reserves the right to make modifications and alterations to this statements as may be required from time to time without any prior approval. Cholamandalam Securities Limited, its affiliates, directors and employees may from time to time, effect or have effect an own account transaction in or deal as agent in or for the securities mentioned in this report. The recipient should take this into account before interpreting the report.

All investors may not find the securities discussed in this report to be suitable. Cholamandalam Securities Limited recommends that investors independently evaluate particular investments and strategies. Investors should seek the advice of a financial advisor with regard to the appropriateness of investing in any securities / investment strategies recommended in this report. The appropriateness of a particular investment or strategy will depend on an investor’s individual preference. Past performance is not necessary a guide to future performance. Estimates of future prospects are based on assumptions that may not be realized. Re-publication or redistribution in any form, in whole or in part, is prohibited.

No part of this material may be duplicated in any form and/or redistributed without Cholamandalam Securities Limited prior written consent.

The news items appearing in this are collected from various media sources and we make no representations that it is complete or accurate