Recovery of market share a challenge for tractor major Escorts Kubota

Near term volume growth, margins could add to the concerns

The stock of tractor major, Escorts Kubota, slid over 5 per cent in trade on Tuesday, following a weak June quarter for the 2022-23 financial year (Q1FY23) show and a slew of brokerage downgrades. While the company faced margin headwinds in the quarter, the Street is worried about market share losses and prospects of a weak volume trajectory going ahead. Brokerages have cut their earnings estimates for the company between 7-24 per cent for FY23 and FY24.

Even though Escorts revenues grew 20 per cent in Q1, as compared to QIFY22, its operating and net profit fell by 14 per cent and 20 per cent, respectively. While tractor volume growth was limited to 3 per cent, higher sales growth was on account of price hikes in tractors and improvement in the construction equipment and railways segment sales on a low base. The two segments saw a 45-74 per cent growth year-on-year (YoY). Its operating profit missed Street estimates by over 30 per cent.

Despite the rise in revenues, margins faced a double whammy on account of a sharp rise in steel prices and weak product mix. The quarter saw a higher share of lower horsepower tractor sales. where profitability is weaker. Margin drop was a sharp 400 basis points (bps) YoY (310 bps quarter-on-quarter or QoQ) to 10 per cent due to an unfavourable product mix, higher competition, rise in raw material costs and other operating expenses.

The parametres the Street will keep an eye out for are margins, volume trajectory and market share. While tractors started off the financial year on a strong note with improved volumes in April and May, growth started to wane in June and July. This, according to analysts led by Joseph George of IIFL Securities, can be attributed to the recent ban on wheat exports and late onset of monsoons.

The company has been losing market share in the domestic market in recent months and shed 140 basis points y-o-y and 210 basis point QoQ to 9.3 per cent in the quarter. This is on account of a reversal in trend from higher horsepower to lower horsepower units where the company’s position is weaker. Say Rishi Vora and Eswar Bavineni of Kotak Institutional Equities, “Generally, market share in the domestic tractor segment tends to remain sticky and we believe the company will have to adopt an aggressive pricing strategy in order to regain its lost market share, which we believe will have negative impact on profitability of the company.”

What should give relief to the company are softening commodity prices and could act as a tailwind for the company in Q2FY23. IIFL Securities, however, believes that the margin fall in Q1 was so severe that it would take a few quarters for it to normalise. Moreover, the Escorts management would have to do a tight balancing act between improving margins and gaining market-share, as the commodity tailwind would be available to its competitors as well, they add.

Most analysts have a ‘reduce’ or ‘neutral’ rating on the stock. Sharekhan Research has downgraded the stock to ‘neutral’ due to slower industry growth, intensifying competition, margin pressure and limited upside. The stock has gained over 36 per cent over the last one year and despite the correction on Tuesday, it trades at 20 times its FY24 earnings estimates, as against its decadal average of 12 times. Investors should await clarity from the management on Kubota-Escorts partnership before taking an exposure to the stock.