Tractors and construction equipment manufacturer Escorts Ltd’s stock gained 2% on Thursday after the company reported a stronger-than-expected performance for the June quarter. Revenue increased 9% from a year ago. Operating and net profit jumped 52% and 33.5%, respectively, as low raw material costs boosted profitability.
Tractors and rail equipment divisions drove the performance. Tracking the 10% growth in tractor sales, farm equipment revenues rose 8%. Raw material costs as a percentage of sales fell, which helped the division grow its operating profit 32%.
Operating profit at the rail division also outpaced revenue growth. According to Bharat Madan, group financial controller, Escorts, the postponement of certain orders from the earlier quarter and cost reduction measures helped the railway division register a strong performance. With Rs.100 crore worth of orders to be executed over the next seven-to-eight months, the rail unit can do well in the rest of the fiscal year.
But the division alone cannot drive Escorts’ earnings, or the stock. Tractors or the farm equipment division still generates most of the company’s earnings and it is here that there is a bit of a challenge. As tractor sales recovered from a 17% drop in the year-ago quarter, Escorts’ stock gained 82% last year, helping it reduce the valuation gap with industry peers.
At 12 times one-year forward earnings estimate, Escorts is still cheaper than VST Tillers and Tractors Ltd and Mahindra and Mahindra Ltd. But that is due to the variations in product portfolio, growth and margin profiles.
Compared with Mahindra’s 20%, Escorts’ tractor volumes increased 10% last quarter. Even after the recent improvements, the margins at the company-level are in single digits vis-a-vis double-digit margins for Mahindra and VST Tillers. To close the valuation gap or continue to deliver positive shareholder returns, Escorts will have to maintain its current momentum in profitability or see earnings upgrades, which is not easy.
Raw material costs, notably of rubber and steel, rose. This can erode some profitability in the current quarter. Escorts expects to overcome this with better volumes. But that is easier said than done.
Currently, growth in the tractor industry is driven by the southern part of the country, where Escorts has a limited presence. Growth in the northern states, where Escorts is strong, remains subdued. This is the primary reason why its tractor realizations fell last quarter.
That also means Escorts’ volumes grew despite the current tough environment, which is commendable. But if the volumes in the northern market do not pick up from the next quarter as estimated and raw material costs inch up, delivering similar good results in the coming quarters may be difficult.