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Stock Insight: Turning Point

Upturn in businesses and sell-off of loss-making arms to increase cash flow, strengthen bottom line for Escorts

Escorts is the third-largest tractor manufacturing company in the country and a major player in the construction equipment business. Escorts (Idirect Code: ESCORT), incorporated in October 1944 in Lahore, has undergone a major restructuring over the past couple of years by selling off its investments in non-core businesses - like healthcare and telecom - and increasing focus on core areas of agri-equipment and auto components. The company also has presence in service and information technology business segment through its subsidiaries.

In 2003-04, the company sold its entire equity holdings in its mobile telecom subsidiaries Escotel Mobile Communications Ltd and Escorts Telecommunications Ltd to Idea Cellular and exited from cellular mobile business. It has also sold its entire 80 per cent stake in Escorts Heart Institute and Research Centre for Rs 520 crore.

In the past, the finance structure was tilted towards borrowed funds and debt to equity ratio was around 1.9 in 2003-04 and 1.3 in 2004-05 due to higher working capital requirements. The average cost of debts was much higher at 15-18 per cent and the financing cost was the major drag on the bottom line growth in past few years.

Recently, the company has sold its entire 49 per cent stake in Carraro India to its other joint venture partner Carraro SpA, Italy, for around Rs 110 crore. The company is ultilising the proceeds from the sell-offs for repaying its high-cost loans.

The restructuring and realignment initiatives will help in bringing down the costs substantially, thereby supporting the bottom line growth. A fall in the working capital requirements will reduce the need for borrowing and consequently the debt-equity ratio is slated to improve to 0.5 by 2007-08 from 1.3 in 2004-05.

The upturn in company's existing business of tractor and construction equipment and unlocking of investments in loss making subsidiaries would jack up cash inflows and help it emerge as a stronger player.

The growth momentum in the tractor industry is likely to continue on the back of sustainable rise in the GDP and easy financing options. Demand for tractors is expected to grow at a CAGR of 18-20 per cent, a good news for manufacturers like Escorts.

The company, with a total installed capacity of 72,000 units, produces tractors in the 27-75 HP range under three brands names - Escort, Powertrac and Farmtrac. The company is witnessing revival in sales as it was able to resume production by sorting out its financial problems and launching new products across segments along with expanding dealer networks in southern and western regions. The company has a strong distribution network to push sales. It has not only regained its market positions but has also been able to improve it further to number three slot with 13.2 per cent market share during April-June 06 period, after Mahindra and Mahindra and TAFE group.

The company has presence in automobile components, farm equipments, railway ancillaries, bi-wheelers, construction and material handling equipment etc. The company will be a key beneficiary of the buoyancy in the auto-ancillary business where it has a considerable presence and derives around 28 per cent of its revenue from it. It manufactures automobile shock absorbers, telescopic front forks and McPherson struts breaks. It has introduced several new products in this segment for domestic and export markets and is also expanding production by setting up a plant with an investment of Rs 25 crore in Pantnagar, Uttaranchal.

Escorts Construction Equipment (ECEL), a wholly-owned subsidiary of Escorts, manufactures and markets a diverse range of equipment like cranes, loaders, vibratory rollers and forklifts. The demand for material-handling equipment is directly linked to construction activities in the economy. With the reforms process on in full swing, the size of construction industry in India is estimated over $25 billion, offering a huge opportunity to companies like Escorts.

ECEL reported an impressive 36.7 per cent growth in turnover in 2004-05 to Rs 155 crore with net profit of Rs 18 crore. The company currently has a manufacturing capacity of around 4,000 units which in next two-years would be doubled with an investment of Rs 20 crore.

Escorts in the past was weighed down by high raw material and finance costs. Spiralling steel and aluminium prices added to the company's woes. Higher finance costs dragged its losses further down. The company has posted a profit after tax of Rs 30.69 crore for the quarter ended September 30, 2006, compared with Rs 16.53 crore for the corresponding quarter of 2005. Total income for the quarter was Rs 626.65 crore, compared with Rs 681.26 crore for same period last year. The fall in net earnings is 81.43 per cent over the comparable quarter. The figures for the previous accounting period are for 15 months and are not comparable.

The upturn in company's existing business of tractor and construction equipment and unlocking of investments in loss making subsidiaries will beef up cash inflows. The current valuations do not capture the value locked in each of its focus areas which, after the turnaround, may trigger re-rating of the stock. At market price of Rs 115, the stock is trading at 16.5x its standalone FY08E EPS and 10.7x its consolidated FY08E EPS.

The current market price does not capture the earning potential of construction equipment business, which is expected to witness multifold jump over the next 2-3 years.

However, any escalation in raw material costs and a fall in demand for tractors and construction equipments may hit the earning estimates for the company.

Source: Idirect