Escorts Ltd’s flat revenue of Rs.1,028 crore in the December quarter and the tripling in net profit to Rs.28.1 crore from a year back were in line with Bloomberg’s consensus estimates. But, the company’s operating margin of 5.1% was a tad below the year-ago period and nearly 130 basis points (bps) below consensus. One basis point is one-hundredth of a percentage point.
Operating margin was shored up only by the agri-machinery products division, which accounts for around 80% of revenue. Compared with a year earlier, the 9.5% growth in revenue also mirrored a near 6% increase in average realization of the agri-machinery products division. Higher volumes to some extent also pushed up operating margin by 330 bps to 9.3%.
But what took away the sheen was a 9% drop in revenue from the railway segment, which according to the company spokesperson was due to the time lag between getting the letter of intent and the actual awarding of orders. The outlook for the segment is reportedly healthy given that these pending orders should come to fruition in the next couple of quarters. However, that is not so in the construction equipment sector, which registered a whopping 38% drop in revenue, and the travails could continue as long as the infrastructure sector languishes.
Both these divisions, therefore, posted significant losses, which eroded profits earned by the agri-machinery products division. In fact, contraction in construction revenue enhanced the fixed costs due to poor operating leverage—hence, the division posted a loss of Rs.5.7 crore as opposed to a profit (before interest and tax) of Rs.3.2 crore a year-ago.
Escorts has been riding the relatively robust northern and eastern markets compared with the south, where sales were down in the last few months. The management expects an 8-10% annual growth during its current fiscal ending September 2013, although analysts expect tardy growth in the sector as a whole.
This is perhaps why Escorts stock has widely underperformed the BSE-500 index. Besides, its profitability has been volatile due to a poor performance of the very segments that are supposed to offset the seasonality of the agri-machinery products business. That, too, has weighed on its valuations.
The Escorts stock trades at Rs.67 at a one-year price-to-earnings multiple of 8.9. Unless the agri-machinery products segment posts robust growth and the profitability stabilizes across business segments, its valuation is unlikely to improve.