Rating Matrix Farm Mechanisation -...

July 10, 2015

ICICI Securities Ltd | Retail Equity Research

Sector Thematic

Way forward for Indian agriculture… India commands ~2.4% of the global geographic area and has access to ~4% of the total water reserves for supporting a mammoth ~18% of the total global population and ~15% of the total global livestock. Thus, lack of natural resources like land & water and increasing infrastructural development limits the ability to increase cultivable land. Hence, this makes a compelling case for increasing crop yields domestically. Farm mechanisation i.e. usage of machinery and technology (e.g. tractors, tillers, transplanters, harvester, pumps, etc.) in farming is the most sought after solution for increasing farm yields given increasing concerns over pesticide residues in our food value chain & shortage of farm labour on account of a shift in labour from rural to urban and diversion of workforce in MGNREGA. Hence, with a positive view on the future of farm mechanisation domestically coupled with the central government’s thrust on its increasing penetration, we initiate coverage on two foremost companies in this segment i.e. VST Tillers & Tractors (VST) and Swaraj Engines (SEL) with a BUY recommendation. The key risk to our call is adverse weather conditions (including below normal monsoons) and a delay in farm equipment subsidy release by various state governments. VST - leader in power tiller segment, tractor division at inflection point; recommend BUY, TP: | 1845, valuing at 18x P/E on FY17E EPS of | 102.5 VST is a farm equipment manufacturer. The company manufactures power tillers and tractors. For VST, sales volumes of power tillers have grown at 10.3% CAGR in FY07-15 to 23104 units in FY15 with average market share at 46% in the aforesaid period. The domestic power tiller industry is subsidy driven and dependent on collective planning and execution by state governments. Among power tillers, we expect sales to grow at a CAGR of 13.0% in FY15-17E backed by volume CAGR of 15.9% (FY17E sales volume at 31046 units). On the tractor front, VST is a strong player in small agricultural tractors and manufactures tractors that are <30 hp. Sales volumes of tractors at VST have grown at a CAGR of 20.2% in FY07-15 to 6694 units in FY15. The management has put in place a new marketing team with focus on augmenting the penetration of its product in different geographies in FY16E-17E. In the tractor segment, we expect sales to grow at a CAGR of 14.3% in FY15-17E backed by volume CAGR of 17.3% (FY17E sales volume at 9204 units). On a consolidated basis, we expect sales and PAT to grow at a CAGR of 13.7% and 12.9%, respectively, in FY15-17E. We have valued VST at | 1845, i.e. 18x P/E on FY17E EPS of | 102.5 and assigned a BUY rating to the stock. SEL; major supplier to Swaraj brand of tractors (M&M owned); recommend BUY, TP | 1110, valuing at 20x P/E on FY17E EPS of | 55.5 SEL is a manufacturer of engines domestically for the ‘Swaraj’ brand of tractors. The company caters to ~85% of engine requirement of Swaraj tractors (~15% supplied by Kirloskar Oil Engines) wherein it manufacturers engines catering to the 20-50 horse power (hp) tractors segment. With its fortunes directly linked to Swaraj tractors, which has a prominent market share (~14%) domestically, SEL is on a strong footing with increasing sales & profitability, going forward. We expect sales, PAT to grow at a CAGR of 12.7%, 15.4%, respectively, in FY15-17E. On the volume front, we expect engine sales to grow at a CAGR of 12.1% in FY15-17E to 81130 units in FY17E (64595 units in FY15). SEL has excellent return ratios with FY15 RoCE, RoE coming in at 29.0%, 24.4% respectively. The company also maintains a healthy dividend payout with average payout in FY13-15 at 73% with current dividend yield at ~4% (dividend/share at | 33 in FY15). We have valued SEL at | 1110, i.e. 20x P/E on FY17E EPS of | 55.5 and assigned a BUY rating to the stock.

Farm MechanisationRating Matrix

Company CMP

(|) Target

(|) Upside

(%) Rating VST Tillers & Tractors 1,572 1,845 17 BuySwaraj Engines Ltd 870 1,110 28 Buy

Key Financials (VST) | Crore FY14 FY15 FY16E FY17ENet Sales 624 550.1 583.2 710.8 EBITDA 118.9 100.3 96.2 124.4 Net Profit 82.9 69.5 66.8 88.6 EPS (|) 95.9 80.4 77.3 102.5

Valuation summary (VST) FY14 FY15 FY16E FY17E

P/E 16.4 19.6 20.3 15.3 Target P/E 19.2 22.9 23.9 18.0 EV / EBITDA 10.4 12.5 12.3 9.1 P/BV 4.4 3.7 3.2 2.8 RoNW 26.5 19.1 16.0 18.2 RoCE 36.8 25.0 20.5 23.3

Key Financials (SEL) | Crore FY14 FY15 FY16E FY17ENet Sales 608.3 539.7 564.9 685.6 EBITDA 90.6 74.7 82.2 103.1 Net Profit 67.0 51.8 56.1 68.9 EPS (|) 53.9 41.7 45.2 55.5

Valuation summary (SEL) FY14 FY15 FY16E FY17E

P/E 16.1 20.9 19.3 15.7 Target P/E 20.6 26.6 24.6 20.0 EV / EBITDA 10.0 12.0 11.0 8.6 P/BV 5.1 5.1 5.0 4.7 RoNW 31.9 24.4 25.8 30.2 RoCE 38.8 29.0 31.5 38.6

Stock Data Stock Data VST SELMarket Capitalization | 1358.2 Crore | 1080.5 CroreTotal Debt (FY15) | 0 Crore | 0 CroreCash and Investments (FY15) | 104.2 Crore | 181.9 CroreEV | 1254 Crore | 898.6 Crore52 week H/L 1955 / 1108 1073 / 742Equity capital | 8.6 Crore | 12.4 CroreFace value | 10 | 10MF Holding (%) 9.6 9.2FII Holding (%) 8.1 6.8

Comparative return matrix (%) Return % 1M 3M 6M 12MVST Tillers & Tractors 9.8 20.6 12.0 (14.3) Swaraj Engines 18.3 7.3 4.8 (0.4) M&M 6.1 0.9 3.6 5.6

Research Analyst

Chirag J Shah [email protected]

Shashank Kanodia [email protected]


Table of Contents

1. Farm Mechanisation

a) Introduction

b) Farm power & its sources in India

c) Farm mechanisation: Penetration in India

d) Tractors & tillers at the forefront

e) Savings generated from farm mechanisation

f) Main drivers

g) Government support & thrust - SMAM

h) Impediments

i) Conclusion

j) Monsoon 2015 update

2. VST Tillers & Tractors

a) Company Background

b) Investment Arguments

c) Financials

d) Risk & Concerns

e) Valuation

f) Financial Statements

3. Swaraj Engines

a) Company Background

b) Investment Arguments

c) Financials

d) Risk & Concerns

e) Valuation

f) Financial Statements


Farm mechanisation Introduction India commands ~2.4% of the global geographic area and has access to ~4% of the total water reserves to support a mammoth ~18% of the total global population and ~15% of the total global livestock. Thus, lack of natural resources like land & water and increasing infrastructural development limits the ability to increase cultivable land. Hence, this makes a compelling case for increasing crop yields domestically. Farm mechanisation i.e. usage of machinery and technology (e.g. tractors, tillers, transplanters, harvesters, pumps, etc.) in farming is the most sought after solution for increasing farm yields. This is given the increasing concerns over pesticide residues in our food value chain, shortage of farm labour on account of a shift in labour from rural to urban areas and diversion of workforce in MGNREGA. Exhibit 1: Mechanisation rate vs. Population engaged in agriculture (2011)

40

95 95

8075

38

55

2.4 3.914.4 14.8

65

0

20

40

60

80

100

India US WesternEurope

Russia Brazil China

%

Mechanization Rate % Population engaged in agriculture

Source: Ministry of Agriculture, ICICIdirect.com Research

Comparing India vis-à-vis its global competitors in the agri space, the level of mechanisation in India as of 2010-11 is ~40% while the share of the population engaged in agriculture is ~55%. The corresponding figures for developed countries like the US are 95% and 2.4%. For a developing country like Brazil the corresponding figures are 75% and 14.8%, depicting the high intensity of manual labour in India vis-à-vis its global competitors.

Scope of farm mechanisation Farm mechanisation i.e. usage of technology and equipment in performing various tasks in the agricultural field has wide scope. It entails major agri tasks like seedbed preparation, sowing/planting, fertiliser application, irrigation and harvesting, among others.

Exhibit 2: Scope of work in India (2011)Agriculture Operation Penetration in India (%)

Soil working & seed bed preparation 40

Seeding & Planting 29

Plant Protection 34

Irrigation 45

Harvesting & threshing 60-70 for wheat & rice; <5% for others

Overall ~40-45%


In India, it has been observed that maximum mechanisation is undertaken while preparing the seed bed (penetration levels at ~40%) and irrigation (penetration levels ~45%) while the total mechanisation rate is ~40-45%.

In China, the farm mechanisation rate is 38% while its share of the population engaged in agriculture is 65%. This implies a similar case to India wherein mechanisation rates are low and the percentage share of population engaged in agriculture is high

Specifically, in case of wheat and rice, mechanisation is also undertaken while harvesting the crop with penetration levels at ~60-70% domestically


Major farm machinery used in India Major farm machinery used in India includes tractors, threshers and power tillers, among others. Among these, the biggest market in terms of annual sales is that of tractors (~6 lakh units annually), threshers (~1 lakh units annually) and power tillers (~56,000 units annually).

Exhibit 3: Major farm machinery used in India Name of Machinery Market Size Annually (units) Per unit costs (US$/unit) Average per unit costs (|/unit) Annual Industry Size (| crore)

Tractor 600000 7000-12000 570000 34200

Power Tiller 56000 2100 126000 706

Combine Harvester 4000-5000 22000-35000 1710000 770

Thresher 100000 1600-2500 123000 1230

Rotavator 60000-80000 1300-2000 99000 693

Rice Transplanter 1500-1600 62

Walking Type 2500-4200 201000

Riding Type 3300-16600 597000

Self-propelled reaper 4000-5000 1300-2000 99000 45

Zero till seed drill 25000-30000 750-850 48000 132

Multi -crop planter 1000-2000 850-1000 55500 8

Laser land leveller 3000-4000 5800-6500 369000 129

Power Weeder 25000 8500 510000 1275

Source: Trends of Agricultural Mechanisation in India CSAM Policy Brief, June 2014, ICICIdirect.com Research USD:INR::1:60

The tractor market is by far the largest (both in volume and value terms). Among farm machinery, tractors are most widely used by domestic farmers with the total market size estimated at ~| 34,000 crore annually (~6 lakh units).

Gross capital formation & institutional credit flow Gross capital formation (GCF), which represents the capex incurred on plants and machinery, is on the rise in the Indian agriculture sector with GCF as a percentage of GDP in agriculture and allied sector increasing from 14.6% in FY06 to 21.2% in FY13.

Exhibit 4: Gross capital formation in agriculture, allied sectors

FY06 86604 594487 14.6

FY07 92057 619190 14.9

FY08 105741 655080 16.1

FY09 127127 655689 19.4

FY10 133162 660987 20.1

FY11 132734 717814 18.5

FY12 157172 753832 20.8

FY13 162084 764510 21.2

YearGCF, Agriculture and Allied

Sector (| cr)GDP, Agriculture and Allied

Sector (| cr)GCF as a % of

GDP (%)


Exhibit 5: Agriculture credit flow

YearAgricultural Credit,

Target (| cr)Agricultural Credit,

Achieved (| cr) % AchievedYoY Growth

(%)FY09 280000 287149 103FY10 325000 384514 118 33.9FY11 375000 468291 125 21.8FY12 475000 511029 108 9.1FY13 575000 607375 106 18.9FY14 700000 730765 104 20.3FY15 800000 NA NA NAFY16E 850000 NA NA NA


On the institutional credit front, the agriculture credit target set by the central government is also on the rise in India. Institutional credit has grown at 17.2% CAGR in FY09-16E, implying greater focus on flow of institutional credit to domestic farmers, thereby promoting greater usage of quality farm inputs for augmenting domestic crop yields.


Farm power Tracking the level of farm mechanisation in India through the globally accepted Index of Agriculture Mechanisation i.e. power availability per unit area, it has been observed that mechanisation levels have improved in India over a period of time. The speed, however, has been a tad slow. Exhibit 6: Farm power availability in India (kW/ha)

0.3 0.3 0.4

0.6

0.9

1.4

1.71.8

0.0

0.5

1.0

1.5

2.0

1950-51 1960-61 1970-71 1980-81 1990-91 2000-01 2010-11 2012-13

kw/h

a


Sources of farm power in India In India, farm power i.e. mechanical power used in farms, is available through various sources that include agriculture workers, tractors, tillers and diesel engines, among others.

Exhibit 7: Sources of farm power available in Indian agriculture (kW/ha)

1971-72 0.045 0.133 0.02 0.001 0.053 0.041 0.2931975-76 0.048 0.135 0.04 0.001 0.078 0.056 0.3581981-82 0.051 0.128 0.09 0.002 0.112 0.084 0.4671985-86 0.057 0.129 0.14 0.002 0.139 0.111 0.5781991-92 0.065 0.126 0.23 0.003 0.177 0.159 0.761995-96 0.071 0.124 0.32 0.004 0.203 0.196 0.9182001-02 0.079 0.122 0.48 0.006 0.238 0.25 1.1752005-06 0.087 0.12 0.7 0.009 0.273 0.311 1.52011-12 0.1 0.119 0.804 0.014 0.295 0.366 1.6982012-13 0.093 0.094 0.844 0.015 0.3 0.494 1.841

Electric MotorDraught Animals Tractors Total PowerYear

Agriculture Workers Power Tillers Diesel Engine

Source: Trends of Agricultural Mechanisation in India CSAM Policy Brief, June 2014, ICICIdirect.com Research

Exhibit 8: Composition of farm power in India

15.4 13.4 10.9 9.9 8.6 7.7 6.7 5.8 5.9 5.1

45.437.7

27.4 22.3 16.6 13.5 10.4 8.0 7.0 5.1

6.811.2

19.3 24.2 30.3 34.9 40.9 46.7 47.3 45.8

18.1 21.8 24.0 24.0 23.3 22.1 20.3 18.2 17.416.3

14.0 15.6 18.0 19.2 20.9 21.4 21.3 20.7 21.6 26.8

0

20

40

60

80

100

1971-72 1975-76 1981-82 1985-86 1991-92 1995-96 2001-02 2005-06 2011-12 2012-13

%

Agriculture Workers Draught Animals Tractors Power Tillers Diesel Engine Electric Motor

Source: Trends of Agricultural Mechanisation in India CSAM Policy Brief, June 2014, ICICIdirect.com Research

Thus, it can been observed that slowly and steadily India has been progressing towards greater farm mechanisation with the share of agricultural workers in total farm power declining from 15.4% in 1971-72 to 5.1% in 2012-13. On the other hand, the share of tractors in total farm power has increased from 6.8% in 1971-72 to 45.8% in 2012-13.

The total farm power availability in India in 1971-72 was at 0.3 kW/ha while the same in 2012-13 was at 1.8 kW/ha

For calculating farm power availability, the following standards of power equivalent are followed; 1 human (agri worker) = 0.05 kW, draught animal pair = 0.38 kW, power tiller = 5.6 kW; tractor = 26.1 kW, electric motor = 3.7 kW, diesel engine = 5.6 kW All these power equivalent numbers (after multiplying with the respective available units) are finally divided by total sowable area to arrive at the farm power availability per source in kW/ha Kw/ha = (number of agricultural workers x 0.05+number of draught animal x 0.38 +number of tractors x 26.1+ number of power tillers x 5.6 + number of electric motors x 3.7 + number of diesel engines x 5.6) ÷ available cultivated land in hectare (ha)


Farm mechanisation: Penetration in India Tractors, tillers at the forefront of mechanisation wave Tractors and power tillers have been at the forefront of driving the mechanisation wave in India. Tractor sales have grown at a CAGR of 9.0% in FY05-15 to ~5.5 lakh tractors in FY15 (~2.3 lakh in FY05) while sales of power tillers have grown at a CAGR of 10.6% in FY05-15 to 48,000 power tillers in FY15 (17481 in FY05).

Exhibit 9: Tractors & power tiller sales in India Year Tractors Sold (Nos) Power Tillers Sold (Nos)FY05 232906 17481FY06 264790 22303FY07 313941 24791FY08 302948 26135FY09 304622 35294FY10 402586 38794FY11 482286 55100FY12 536891 60000FY13 527768 47000FY14 634151 56000FY15 551463 48000

Source: Crisil, Ministry of Agriculture, ICICIdirect.com Research

Penetration of tractors in India is higher in northern India, mainly Punjab and Haryana. On the other hand, the penetration of power tillers in India is higher in southern and eastern India. This is on account of the small size of land holdings per farmer in these respective regions.

Exhibit 10: Farm mechanisation tilted towards northern states like Punjab & Haryana (2011)



Savings from farm mechanisation Savings generated from farm mechanisation include savings of inputs viz. seeds (~15-20%), fertilisers (~15-20%), increase in cropping intensity (~5-20%), saving in time (~20-30%) and reduction in manual labour (~20-30%) with an overall increase in farm productivity at ~10-15%.

Exhibit 11: Farm mechanisation (farm power) vs. domestic farm yield

522710

8721023

13801626

1930

0.3 0.3 0.4

0.6

0.9

1.4

1.7

0

500

1000

1500

2000

2500

1950-51 1960-61 1970-71 1980-81 1990-91 2000-01 2010-11

Kg/h

ecta

re

00.20.40.60.811.21.41.61.8

Kw/h

a

Yield (LHS) Farm Power (RHS)


It has been observed that farm mechanisation is directly proportional to farm efficiencies and enhanced crop yields. On the yield front, average domestically food grain yield has increased from 522 kg/hectare in 1950-51 to 1930 kg/hectare in 2010-11 primarily on the back of increasing penetration of irrigation facilities, hybrid seeds and farm mechanisation. Main drivers for increasing farm mechanisation domestically

Increasing demand for foodgrains

As per the Vision 2030 document released by the Indian Council of Agricultural Research, domestic demand for foodgrains is expected to increase at ~2% CAGR in CY00-30. Foodgrain demand is expected to reach 355 million tonne (MT) in CY30 vis-à-vis 192 MT in CY10. Fruits & vegetables demand is expected to reach 290 MT in CY30 vis-à-vis 136 MT in CY10.

India’s domestic population has grown from 36.1 crore in 1950-51 to 121 crore in 2010-11 (at 2% CAGR). Going forward, as per the estimates of United Nations (UN), India’s population is expected to grow at 1% CAGR to 145 crore by 2028, giving rise to tremendous demand for foodgrains. However, given the limitations in land use and in increasing cropping intensity over a certain period, increasing the yield from the same land is an urgent necessity to meet the needs of a growing domestic population.

Exhibit 12: Foodgrains demand expected to increase at ~2% CAGR in CY00-30

14 3364 81

192

4393 76

30

102 95156

355

110

180 182

050

100150200250300350400

Puls

es

Cere

als

Whe

at

Rice

Food

Grai

ns

Frui

ts

Vege

tabl

es

Milk

milli

on to

nne

CY2000 CY2030

Source: Indian Council of Agricultural Research – Vision 2030, ICICIdirect.com Research


Scope for yield improvement In India, crops yields have improved over a period of time. The yield of farmlands producing foodgrains has improved from 522 kg/hectare in 1950-51 to 1930 kg/hectare in 2010-11, representing a CAGR of ~2.2% in the aforesaid period. However, the progress of the same has been rather slow in the last decade. Hence, yields of foodgrains have increased from 1626 kg/hectare in 2000-01 to 2098 kg/hectare in 2013-14, representing a CAGR of ~2% in the aforesaid period.

Exhibit 13: Foodgrains: yield per hectare (1950-2011)

522710

8721023

13801626

1930

0

500

1000

1500

2000

2500

1950

-51

1960

-61

1970

-71

1980

-81

1990

-91

2000

-01

2010

-11

kg/h

ecta

re


Exhibit 14: Foodgrains: yield per hectare (2000-2014)

1626 1535 1652 17571909 1930

2128 2098

0

500

1000

1500

2000

2500

2000

-01

2001

-02

2002

-03

2003

-04

2004

-05

2005

-06

2006

-07

2007

-08

2008

-09

2009

-10

2010

-11

2011

-12

2012

-13

2013

-14

kg/h

ecta

re


India’s yield of food grains lags considerably vis-à-vis that of global peers

Exhibit 15: Paddy, yield per hectare (2012)

164

31 43 13 8

718

206153

69 44

4394

6735

3591

51535639

0100200300400500600700800

World China India Indonesia Vietnam

milli

on

010002000300040005000600070008000

kg/h

ecta

re

Area (million hectare) Production (million tonne)

Yield (kg/hectare)


Exhibit 16: Maize, yield per hectare (2012)

177

35 35 14 8

875

274208

71 21

4944

7734

59495021

2512

0

200

400

600

800

1000

World USA China Brazil India

milli

on

0100020003000400050006000700080009000

kg/h

ecta

reArea (million hectare) Production (million tonne)

Yield (kg/hectare)


As is evident from the above charts, in case of paddy, domestic yields, as of 2012, were at 3591kg/hectare vs. the global average of 4394 kg/hectare. Similarly, in case of maize, which is the most widely produced crop globally, India’s yield is 2512 kg/hectare vs. the global average of 4944 kg/hectare.


Modest hike in MSPs; farmers need to innovate in farm practices for better earnings In a recent meeting, the Cabinet Committee on Economic Affairs (CCEA) approved a modest hike in MSPs for domestic crops, thereby not paying heed to the popular demand for a steep hike in MSPs due to a distress in the rural economy. A modest hike in MSPs emphasises the government’s stance on equitable growth domestically wherein factors of demand and supply as well global commodity prices were taken into consideration for fixing the MSP price. The MSP for rice (common grade) was increased by | 0.5/kg (up 3.7%) to | 14.1/kg in FY16 from | 13.6/kg (FY15). The government, however, provided incentives to farmers growing pulses by declaring a bonus of | 2.5-2.7/kg over and above the increase in MSP (India imports ~3 MT pulses annually, worth ~| 10,000 crore).

Exhibit 17: MSP trend in India FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

Common 9.0 10.0 10.0 10.8 12.5 13.1 13.6 14.1 3.7Grade A 9.3 10.3 10.3 11.1 12.8 13.5 14.0 14.5 3.6

Maize 8.4 8.4 8.8 9.8 11.8 13.1 13.1 13.3 1.1Arhar 20 23 30 32 38.5 43.0 43.5 46.3 6.3Moong 25.2 27.6 31.7 35 44 45.0 46.0 48.5 5.4Urad 25.2 25.2 29 33 43 43.0 43.5 46.3 6.3

Medium Staple 25 25 25 28 36 37.0 37.5 38.0 1.3Long Staple 30 30 30 33 39 40.0 40.5 41.0 1.2

Wheat 10.8 11 11.7 12.85 13.5 14 14.5 NA NARabi Crops

(|/kg) Kharif Crops

YoY Growth (%)

Paddy

Cotton

Source: Government of India, Ministry of Agriculture, ICICIdirect.com Research

Thus, a modest increase in MSP leaves little room for farmers to augment their annual farm income with the only option being to garner higher yields from their existing farmlands through innovative farm practices. This bodes well for all agri input companies in the agro-chemical, seed, fertiliser as well as farm mechanisation space. This may result in higher farm mechanisation, going forward. Shortage of farm labour The next main leg of growth in farm mechanisation will automatically come from the shortage of farm labour, wherein labour has started to get diverted to other means of livelihood, a shift in labour from rural to urban along with diversion of workforce on account of MGNREGA.

Exhibit 18: Population dynamics of Indian workers

S. No Particulars 1991 2001 2011 2020 2050

1 Country’s population 846.4 1028.7 1210.7 1323 1612

2 Total no. of workers 313.7 402.2 481.7 566 787

3 No. of workers as % of population 37.1 39.1 39.8 42.8 48.8

4 No. of agricultural workers 185.3 234.1 263 230 202

Cultivators 110.7 127.3 118.7 110 -

Agricultural labourers 74.6 106.8 144.3 120 -

5 % of agricultural workers to total workers 59.1 58.2 54.6 40.6 25.7

Population dynamics of Indian agricultural workers (No. in million)

Source: *Vision 2050 document of Central Institute of Agricultural Engineering, Bhopal, ICICIdirect.com Research

It has been observed that the percentage of agricultural workers to total workers in India has been gradually declining from 59.1% in 1991 (total agricultural workers at 185.3 million vs. total workers at 313.7 million) to 54.6% in 2011 (total agricultural workers at 263 million vs. total workers at 481.7 million) and is expected to further decline to 25.7% by 2050, thereby leading to severe shortage of farm labour and consequent switch to farm mechanisation with higher usage of farm machinery domestically.


Government support: Sub-mission on agricultural mechanisation Realising the need to enhance farm mechanisation domestically, the central government under its flagship ministry i.e. Ministry of Agriculture has undertaken various steps to promote the usage of machinery by domestic farmers. The central government’s efforts towards farm mechanisation have been aggregated under a formal programme viz. Sub-Mission on Agricultural Mechanisation (SMAM). It came into existence during the current five year plan (2012-17) at an estimated outlay of ~| 2000 crore (US$ 350 million) over the five year term.

It lays emphasis on custom hiring services through the rural entrepreneurship model, thereby making an effort to reach out to small and marginal farmers.

Exhibit 19: SMAM – Mission components, government’s assistance

Centre State

1Promotion and Strengthening of Agricultural Mechanization through Training, Testing and Demonstration 100 0

State identified institutions, ICAR institutions, PSUs of GOI, State Governments

2Demonstration, Training and Distribution of Post Harvest Technology and Management(PHTM): 100 0

State identified institutions, ICAR institutions, PSUs of GOI, State Governments

3 Financial Assistance for Procurement of Agriculture Machinery and Equipment 50 50 State Governments

4 Establish Farm Machinery Banks for Custom Hiring 50 50 State Governments

5 Establish Hi-Tech, High Productive Equipment Hub for Custom Hiring 50 50 State Governments

6 Promotion of Farm Mechanization in Selected Villages 50 50 State Governments

7Financial Assistance for Promotion of Mechanized Operations/hectare Carried out Through Custom Hiring Centers 50 50 State Governments

8 Promotion of Farm Machinery and Equipment in North-Eastern Region 50 50 State Governments of 8 North eastern States

Implementing Agency

Share of Assistance

S. No Mission Components


Exhibit 20: Financial assistance for procurement of farm machinery & equipment

Pattern of Assistance

(%)

Max permissible subsidy per machine/equipment per

beneficiary (|)Pattern of

Assistance (%)

Max permissible subsidy per machine/equipment per

beneficiary (|)

Tractors

1) 05-15 Hp 25 0.75 lakh 35 1.0 lakh

2) 15-20 Hp 25 0.75 lakh 35 1.0 lakh

3) 20-40 Hp 25 1.0 lakh 35 1.25 lakh

4) 40-70 Hp 25 1.0 lakh 35 1.25 lakh

Power Tillers

1) <8 Hp 40 0.4 lakh 50 0.5 lakh

2) >8 Hp 40 0.6 lakh 50 0.75 lakhSelf Propelled Rice Transplanter

4 rows 40 0.75 lakh 50 0.94 lakh

8 rows 40 2.0 lakh 40 2.0 lakh

16 rows 40 2.0 lakh 40 2.0 lakhSelf Propelled Machinery

Reaper cum Binder 40 1.0 lakh 50 1.25 lakh

Paddy Thresher 0.2 lakh 0.25 lakh

For SC, ST, Small & Marginal farmers,Women and NE States beneficiary

Agriculture Machinery

For General Farmers


SMAM is being mandated to improve farm power availability domestically, from a national average of 1.73 kW/ha (currently) to 2.0 kW/ha

It has been observed that in case of tractors meant for agricultural purposes, the average subsidy (financial assistance) provided is 25% of the cost of tractor (maximum | 1 lakh per beneficiary) while the same for SC, ST, small and marginal farmers, women and NE states beneficiary is 35% (maximum | 1.25 lakh per beneficiary). The subsidy for power tillers is 40% (maximum | 0.6 lakh per beneficiary) and 50% (maximum | 0.75 lakh per beneficiary), respectively


Impediments The main impediments for farm mechanisation in India are small and fragmented farm holdings, consequent high cost of farm equipment ownership and lack of credible financing options for domestic farmers.

Small, fragmented farm holdings In India, the average size of operational holding has reduced from 1.33 hectare per holding in FY01 to 1.23 hectare per holding in FY06 and further to 1.15 hectare per holding in FY11. The proportion of marginal & small holding as a percentage of total holdings is also on the rise in India. It has increased from 81.8% in 2000-01 to 85% in 2010-11.

Exhibit 21: India - Farm holdings break-up

2000-01 2005-06 2010-11 2000-01 2005-06 2010-1175.4 83.7 92.4 29.8 32 35.422.7 23.9 24.7 32.1 33.1 35.1

14 14.1 13.8 38.2 37.9 37.56.6 6.4 5.9 38.2 36.6 33.71.2 1.1 1 21.1 18.7 17.4

119.9 129.2 137.8 159.4 158.3 159.11.33 1.23 1.15

81.8 83.3 85.0

Small (1-2 hectare)Semi-Medium (2-4 hectare)

No of Holding (million number) Area (million hectare)Category of HoldingsMarginal (<1 hectare)

Medium (4-10 hectare)

g g(hectare/holding)p gholdings (%)

Large (>10 hectare)

All Holdings


The overall land holding in India is fragmented. Also, a large proportion of this land holding is held by farmers in the small & marginal category. This had led to challenges in economies of scale of farm machinery. This acts as a deterrent to augmentation of farm mechanisation in India. It has been envisaged and implemented, to some extent, by authorities that the issue can be addressed through the concept of “custom hiring” or “collective ownership” of farm equipment.

Conclusion

Therefore, given the growing population domestically and change in population demographics, there is strong demand for foodgrains including cereals, fruits and vegetables, going forward. An increase in crop yields is the only solution to this problem since there is very limited opportunity to increase sowable farm land. Among methods of increasing farm productivity domestically, farm mechanisation is the most sought after solution. The others are increasing usage of agro-chemicals, correcting the composition of fertilisers (N:P:K ratio), increasing usage of hybrid seeds and better irrigation facilities. Farm mechanisation is also essential in augmenting the earning capacity of rural farmers and consequent progress of Indian society, as a whole. Growth in agri GDP is a prerequisite to achieve an overall national GDP growth target of 8% & above in the long term, going forward. Therefore, given the current emphasis of the central government on augmenting the share of manufacturing in total GDP and consequent shortage of farm labour, farm mechanisation is the way forward for Indian agriculture. The only perennial risk is adverse weather conditions.


Monsoon; IMD sounds caution; initial signs encouraging The Indian Meteorological Department (IMD) has revised downward its rainfall forecast for the upcoming south west monsoon to 88% of the long period average (LPA) vs. the earlier forecast of 93% of LPA, primarily on the back of development of strong El Niño conditions. Private weather agency Skymet still maintains its forecast of normal monsoons at ~102% of LPA for the current upcoming season.

The initial start of the monsoon (at ~13%+ of LPA) after hitting the Indian shores (~June 5, 2015) is quite encouraging for domestic farmers, with spatial distribution of rains at satisfactory levels. The further progress of monsoons in July and August, when a majority of the monsoon rainfall occurs, will need to be closely watched to gauge the impact of monsoons on the domestic agricultural sector.

Exhibit 22: India Chart - South west monsoon (June 1-July 8, 2015)

Source: Indian Meteorological department (IMD), ICICIdirect.com Research

Exhibit 23: Monsoon summary (June 1-July 8, 2015)

Regions Actual Rainfall (mm) Normal Rainfall (mm) % Departure form LPACountry as a whole 224.5 233.5 -4Northwest India 122.4 112.1 9Central India 224.7 243.8 -8South Peninsula 201.4 215.5 -7East & northeast India 449.4 467.6 -4Source: Indian Meteorological department (IMD), ICICIdirect.com Research

Monsoon Categorization (IMD) Monsoon Categorization Rainfall Range (% of LPA)Deficient <90Below Normal 90-96Normal 96-104Above Normal 104-110Excess >110

Source: IMD, ICICIdirect.com Research

IMD defines a normal monsoon as a monsoon season wherein rainfall is in the range of 96-104% of its LPA with below normal monsoon being one where rainfall is in the range of 90-96% of its LPA

However, domestically, sowing has been upbeat post the initial spell of rains with cumulative sowing at ~31 million hectares (MH) in June 1-July 3, 2015 vs. 19 MH in the corresponding period last year. Sowing has been robust in pulses (up 133% YoY), oilseeds (up 404% YoY) and cotton (up 70% YoY) crops with special emphasis on pulses wherein the central government has announced a special bonus in terms of enhanced MSPs for growing pulses, which are largely imported for domestic consumption

Domestically, cumulative rainfall during this current year monsoon has so far been 4% below the long period average (LPA). Rainfall activity was excess only over Northwest India.


Quality play in farm mechanisation... VST Tillers & Tractors (VST) is a farm equipment manufacturer wherein it manufactures power tillers (capacity 60,000 units) and tractors (capacity 36,000 units) at its facilities in Bengaluru and Hosur, Tamil Nadu, respectively. The company is a leading power tiller player domestically with sales volumes growing at 10.3% CAGR in FY07-15 to 23104 units in FY15 with average market share at 46% in the aforesaid period. On the tractors front, VST is a strong player in small agricultural tractors and manufactures tractors that are <30 hp. Sales volumes of tractors for VST have grown at 20.2% CAGR in FY07-15 to 6694 units in FY15. The central government is focused on increasing farm mechanisation domestically while VST is focused on maintaining its market share among power tillers while at the same time increasing the market share in low hp tractors. Hence, we expect VST to clock sales and PAT CAGR of 13.7% and 12.9%, respectively, in FY15-17E. We have valued VST at | 1845, i.e. 18x P/E on FY17E EPS of | 102.5 and assigned a BUY rating to the stock. Power tiller segment - subsidy driven; mandate to maintain market share! The domestic power tiller industry is subsidy driven and dependent on collective planning and execution by state governments. The average subsidy that a farmer receives for a power tiller is in the range of | 40,000-60,000 per unit, which costs ~| 1.2-1.4 lakh, implying a subsidy support of ~30-40%. We believe the tiller division will continue to provide steady cushion to growth as VST’s key prerogative is to maintain its market share in the range of 45-48%. Going forward, we expect sales in the power tiller segment to grow at 13.0% CAGR in FY15-17E to | 377 crore in FY17E (| 295 crore in FY15) backed by volume CAGR of 15.9% in FY15-17E to 31046 units in FY17E (23104 units in FY15). Tractor segment to be main growth driver, going forward! In the recent past (FY14), VST has shifted its tractor manufacturing facility to Hosur (Tamil Nadu) with an enhanced capacity to manufacture 36,000 tractors annually. The management has put in place a new marketing team with focus on augmenting penetration of its product in different geographies, viz. Bihar and South India. Going forward, on the back of enhanced capacity and renewed focus on the tractor business, we expect sales at the tractor segment to grow at 14.3% CAGR in FY15-17E to | 230 crore in FY17E (| 176 crore in FY15). This will be backed by volume CAGR of 17.3% in FY15-17E to 9204 units in FY17E (6694 units in FY15). Lean balance sheet, robust prospects, quality play! VST is a debt free company with cash & cash equivalents of | 104 crore as of FY15. It also boasts of superior return ratios with five year (FY11-15) RoCE, RoE at 32%, 24%, respectively. VST is essentially a quality play and should be held in one’s portfolio with long term investment horizon.

Exhibit 24: Financial Performance (Year-end March) FY13 FY14 FY15 FY16E FY17ENet Sales (| crore) 481.7 624.2 550.1 583.2 710.8 EBITDA (| crore) 72.1 118.9 100.3 96.2 124.4 Net Profit (| crore) 48.6 82.9 69.5 66.8 88.6 EPS (|) 56.2 95.9 80.4 77.3 102.5 P/E (x) 28.0 16.4 19.6 20.3 15.3 Price / Book (x) 5.6 4.4 3.7 3.2 2.8 EV/EBITDA (x) 18.4 10.4 12.5 12.3 9.1 RoCE (%) 28.1 36.8 25.0 20.5 23.3 RoE (%) 19.9 26.5 19.1 16.0 18.2

Source: Company, ICICIdirect.com Research

Rating Matrix

Rating : BuyTarget : | 1845Target Period : 12-18 monthsPotential Upside : 17%

YoY Growth (%) (YoY Growth) FY14 FY15 FY16E FY17ENet Sales 29.6 (11.9) 6.0 21.9 EBITDA 64.8 (15.6) (4.1) 29.3 Net Profit 70.6 (16.2) (3.9) 32.7 EPS (Rs) 70.6 (16.2) (3.9) 32.7

Valuation Summary

FY14 FY15 FY16E FY17EP/E 16.4 19.6 20.3 15.3 Target P/E 19.2 22.9 23.9 18.0 EV / EBITDA 10.4 12.5 12.3 9.1 P/BV 4.4 3.7 3.2 2.8 RoNW 26.5 19.1 16.0 18.2 RoCE 36.8 25.0 20.5 23.3

Stock Data Stock DataMarket Capitalization | 1358.2 CroreTotal Debt (FY15) | 0 Crore

Cash and Investments (FY15) | 104.2 CroreEV | 1254 Crore52 week H/L 1955 / 1108Equity capital | 8.6 CroreFace value | 10MF Holding (%) 9.6FII Holding (%) 8.1

Price Performance Return % 1M 3M 6M 12MVST Tillers & Tractor 9.8 20.6 12.0 (14.3) Mahindra & Mahindra 6.1 0.9 3.6 5.6 Escorts 25.1 (3.6) 3.8 7.8 HMT 20.4 (12.1) (33.2) (20.1)

Price Movement

0

500

1,000

1,500

2,000

2,500

Jul-15Nov-14Apr-14Aug-13Jan-13Jun-12

2,0003,0004,0005,000

6,0007,000

8,0009,000

10,000

Price (R.H.S) Nifty (L.H.S)

Research Analysts

Chirag J Shah [email protected]

Shashank Kanodia [email protected]

VST Tillers & Tractors (VSTTIL)| 1572


Company background VST Tillers & Tractors was founded in 1967 as a joint venture in technical collaboration between VST Motors and Mitsubishi Heavy Industries (Japan). Thereafter, over a course of time, VST acquired majority ownership in the company with current holding in excess of 51%. Mitsubishi was classified as the promoter group entity with 2.9% stake in the company. The company has inherited all technical know-how for efficient manufacturing and product development in power tillers & tractors and is a major player in the domestic farm equipment industry.

VST has two manufacturing facilities. In Whitefield (Bengaluru), it manufactures power tillers (9 hp, 13 hp, 15 hp) and has a capacity of 60,000 units annually (in two shifts). In Hosur, Tamil Nadu, it has commenced (April 2014) manufacturing agriculture tractors (18.5 hp, 22 hp) with a capacity of 36,000 units annually (in two shifts). For the new tractor facility in Hosur, VST incurred a capex of ~| 70 crore that was entirely funded from internal accruals. On the sales & marketing front, the company has a network of about 200 dealers & 300 vendors spread across India with most associated with VST for a fairly long time. VST is also present in the segment of rice transplanters & power reapers. The company imports the same from China and Japan and markets them in the domestic market, earning a trading margin on the same. VST also exports a few power tillers & tractors to Africa, Russia, Myanmar, etc. This is limited by high Chinese competition overseas. Exports in FY14 were at | 15.4 crore i.e. ~2% of net sales of VST in FY14. Total net sales in FY15 were at | 550.1 crore (| 623 crore in FY14).

Exhibit 25: Sales segmentation (FY14)


Net Sales

| 623 crore in FY14

Power Tillers

| 342 crore in FY14 (55%)

Tractors

| 194 crore in FY14 (31%)

Rice Transplanters | 13 crore in FY14

(2%)

Spares

| 42 crore in FY14 (7%)

Sales Volume 27252 units;

Realisation | 125661/unit

Market Share 48.7%

Total Market Size at 56000 units

Sales Volume 7452 units;

Realisation | 260682/unit

Market Share

10.5% Total Segmental Sales

70811 units

Others

|31 crore in FY14 (5%)

Not manufactured; Traded goods

Shareholding pattern (%) – Q4FY15

Shareholder's Category Holding (%)Promoters 54.0Institutional Investors 17.7General Public 28.3

FII & DII holding trend (%)

2.3 2.33.3 3.4 3.0 3.4

7.6 8.1

5.3 5.44.5

5.9

8.9

10.69.1 9.6

0

2

4

6

8

10

12

Q1FY

14

Q2FY

14

Q3FY

14

Q4FY

14

Q1FY

15

Q2FY

15

Q3FY

15

Q4FY

15

%

FII DII

FII & DII - Major Shareholders (%) – Q4FY15

Shareholder's Category Holding (%)Pinebridge Investments Asia Ltd 2.9Novastar International Fund 2.2Goldman Sachs India Fund Ltd 1.9ICICI Prudential Mutual Fund 1.3Axis Mutual Fund 1.3HDFC Mutual Fund 1.2


Exhibit 26: Product Profile

It is a versatile machine that carries out all the function of a tractor except that the operator has to walk behind the machine. It is ideally suited for small farmers with wide applications ranging from wet puddling, dry land cultivation, ridging, water pumping and spraying

Power Tillers

Mitsubishi Shakti VWH 120 Power Tiller (Power 9 hp) VST Shakti 130 DI Power Tiller (13 hp) Dragon Shakti 150 DI Power Tiller (15 hp)

Tractors

State-of-the-art technology of Mitsubishi, very low weight and in-built rotary find exclusive application in wet puddling, inter cultivation, spraying for all crops and horticulture requiring less than 5 feet of row width planting

VST Mitsubishi Shakti VT 224 -1D (22 hp) Mitsubishi Shakti MT 180D Tractor (18.5 hp) VST Mitsubishi Shakti VT 224-1D AJAI-4WB (22 hp)

Other farm equipments which are not manufactured but traded upon are: Rice Transplanter & Power Reaper

VST is the pioneer in introduction and leader in mechanised rice transplanter. It deals with both eight row ridding and six row walk behind rice transplanter. VST, power reapers are mechanised units powered by a light weight diesel engine, which assists in harvesting rice, wheat, barley, etc. with rotating blades

VST Shakti VS-4PR(n) Power ReaperVST Yanji Shakti 8 Row Paddy Transplanter



Investment Argument Power tiller; set to be preferred choice of farm equipment In India, the average size of operational holding has reduced from 1.33 hectare per holding in FY01 to 1.23 hectare per holding in FY06 and further to 1.15 hectare per holding in FY11.

Exhibit 27: India - Farm holdings break-up

2000-01 2005-06 2010-11 2000-01 2005-06 2010-1175.4 83.7 92.4 29.8 32 35.422.7 23.9 24.7 32.1 33.1 35.1

14 14.1 13.8 38.2 37.9 37.56.6 6.4 5.9 38.2 36.6 33.71.2 1.1 1 21.1 18.7 17.4

119.9 129.2 137.8 159.4 158.3 159.11.33 1.23 1.15

81.8 83.3 85.0

Small (1-2 hectare)Semi-Medium (2-4 hectare)

No of Holding (million number) Area (million hectare)Category of HoldingsMarginal (<1 hectare)

Medium (4-10 hectare)

g g(hectare/holding)p gholdings (%)

Large (>10 hectare)

All Holdings


Thus, fragmented land holdings belonging to a lot of farmers in the small & marginal category led to challenges over collective ownership of tractors that cost in the range of ~| 2.5-8 lakh/unit. This, in turn, throws up a huge opportunity for the domestic power tiller sector wherein a power tiller costs ~| 1.25 lakh/unit but suffices or is able to perform all requisite agricultural operations performed by a tractor.

We believe that, going forward, given the government’s thrust on increasing farm productivity through greater penetration of farm mechanisation and its support through various subsidy programmes, power tillers may turn out to be the preferred farm equipment by choice for domestic farmers.

Some basic differences between a power tiller and a tractor are mentioned below. On the operational front, both tractors as well as power tillers can perform all agricultural operations viz. soil preparation, tilling, ploughing, cultivating, etc. Both can also be used in transportation, pumping water, spraying, etc. The power applied, however, is lower in case of a power tiller vis-à-vis a tractor.

Exhibit 28: Difference between tractor and power tiller

Characteristics Tractor Power TillerEssential function Pulling/ Hauling and agriculture AgricultureSeat Yes NoOutput High (~>=15 hp) Less vs. tractor (<15 hp)Controlled by (Drive) 4 wheels 2 wheelsExcise Duty Exempt ExemptSteering Has conventional steering No conventional steeringHydraulic Power for Lifting Yes NoSelf Starting function Yes NoMotor Vehicles Act Applicable Not ApplicableRegistration & Driving License Required Not RequiredMaximum Speed 40-50 kmph 15 kmphEngine Multi-cylinder Vertical engines Single Cylinder, horizontal engines

Difference Between a Tractor & Power Tiller

Source: Indiankanoon.org, ICICIdirect.com Research

In the power tiller segment, domestically, since VST is the marker leader (market share in excess of 45%), the company is on a strong footing and is poised to gain, going forward.

The proportion of marginal & small holding as a percentage of total holdings is also on the rise in India. It has increased from 81.8% in 2000-01 to 85% in 2010-11

Globally, power tillers were first introduced in ~1920’s with Japan developing its indigenous design in ~1947 and was introduced in India in ~1963.

Power tillers are also a cost effective source of farm power for small and marginal farmers wherein it is easy to recover the fixed costs and earn good margins from custom hiring services Domestically, power tillers are most suited for paddy (rice) cultivation


Power tillers - base business; VST: segmental leader domestically! Power tillers have been the base business for VST with sales in the segment growing at a CAGR of 14.5% in FY07-15. In FY15, VST’s sales in the power tiller segment came in at | 295 crore, recording de-growth of 14%, primarily on the back of deficient and unseasonal rains in the last two cropping seasons that impacted the purchasing power of domestic farmers. In FY13, the performance of the power tiller segment was muted on account of supply side issues wherein the company was unable to procure its raw material due to a ramp down at its vendors.

Exhibit 29: VST power tiller sales (value)

100118

178212

267301

261

342

295

0

50

100

150

200

250

300

350

400

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

| cr

ore


Exhibit 30: VST power tiller sales (volume & realisation)

1051

0

1217

4

1669

1

1906

8

2344

9

2615

4

2123

1 2725

2

2310

4

113839

127684

111181115088

122745125661

10670496714

94900

0

5000

10000

15000

20000

25000

30000


units

0

20000

40000

60000

80000

100000

120000

140000

|/un

it


On the volumes front, VST’s power tiller sales have grown at a CAGR of 10.3% in FY07-15 to 23104 units in FY15 (10510 units in FY07). On the realisation front, realisations have grown at a CAGR of 3.8% in FY07-15 to | 127684/unit in FY15 (| 94900/unit in FY07).

VST has always maintained its market leadership in the power tiller segment domestically with market share in the range of 42-48% in FY07-15. The other major players are Kerala Agro Machinery (with a market share of ~25%) and Chinese players (with a market share of ~25-30%).

Exhibit 31: Domestic power tillers industry volume

2479

1

2613

5

3529

4

3879

4 5510

0

6000

0

4700

0

5600

0

4800

0

1050

1

1217

4

1669

1

1906

8

2344

9

2615

4

2123

1

2725

2

2310

4

42.4

46.647.3

49.2

42.643.6

45.2

48.148.7

0

10000

20000

30000

40000

50000

60000


num

ber o

f uni

ts

38

40

42

44

46

48

50%

Total Industry Sales VST Sales Market Share

Source: Ministry of Agriculture, Company, ICICIdirect.com Research

Power tiller sales volumes at VST have grown at a CAGR of 10.3% in FY07-15 vs. the industry growth rate of 8.6% in FY07-15, implying a gain in market share by VST. Total industry sales for power tillers domestically were at ~48000 units in FY15 vs. 24791 units in FY07.


Exhibit 32: Power tiller volume growth rate (industry vs. VST)

5.49.9

42.0

8.9

-21.7

19.1

-14.3

15.9

37.1

14.2

23.0

11.5

-18.8

28.4

-15.2

35

-30

-20

-10

0

10

20

30

40

50

FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

%

Industry Sales Growth YoY VST Sales Growth YoY

Source: Ministry of Agriculture, Company, ICICIdirect.com Research

The domestic power tiller industry is subsidy driven and dependent on collective planning and execution by state governments. The average subsidy received by a farmer for a power tiller is in the range of | 40,000-60,000 per unit, which costs ~| 1.2-1.4 lakh, implying subsidy support of ~30-40%. VST has, over a period of time, developed expertise to deal with government agencies (subsidy mechanisms). The company has been able to command a healthy market share and at the same time improved its operating margins. We expect the current trend to continue, going forward, with VST maintaining its dominant market share in the domestic power tiller segment primarily on the back of good quality of its product and strong brand recall. VST’s key prerogative is to maintain its market share in the range of 45-48%.

Exhibit 33: VST power tiller sales (value)

260.6

342.5

295.0 309.2

376.8

0

50

100

150

200

250

300

350

400

FY13 FY14 FY15 FY16E FY17E

| cr

ore


Exhibit 34: VST power tiller sales (volume & realisation)

2123

1

2725

2

2310

4

2483

7

3104

6122745 125661 127684 124491 121379

0

10000

20000

30000

40000


no o

f uni

ts

0

50000

100000

150000

| / u

nit

Sales Volume Realization


Going forward, we expect sales of the power tiller segment to grow at a CAGR of 13.0% in FY15-17E to | 377 crore in FY17E (| 295 crore in FY15). Sales volumes are expected to grow at a CAGR of 15.9% in FY15-17E to 31046 units in FY17E. Realisations are expected to decline at a CAGR of 2.5% in FY15-17E. This is primarily on the back of softer saw material prices (mainly steel). Realisations are expected to reduce from | 127684/unit tin FY15 o | 121379/unit in FY17E.

Historically, it has been observed that VST has always grown ahead of its industry growth rate with average YoY growth rate of the industry in FY08-15 at 10.6% while the same for VST in the aforesaid period was at 12.0%. FY11 and FY15 were exceptional years wherein the volume growth rate at VST was lower than the industry growth rate


Tractor business; renewed focus to drive sales VST is also present in the tractor segment wherein the company manufacturers low hp (18.5 hp & 22 hp) tractors that are meant primarily for agricultural purposes. Sales in this segment have grown at a CAGR of 24.6% in FY07-15 to | 176 crore in FY15 (| 30 crore in FY07). In FY15, VST recorded de-growth of 9% in tractor segment sales. This was primarily on the back of deficient and unseasonal rains in the last two cropping seasons that impacted the purchasing power of domestic farmers.

Exhibit 35: VST tractor sales (value)

30 3450

81

105

165154

194176

0

50

100

150

200

250


| cr

ore


Exhibit 36: VST tractor sales (volume & realisation)

1537

1714 23

27 3758 47

35

7038

6233 74

52

6694

221331

262922

197137

197200213709

260668247714234442

215806

0

1000

2000

3000

4000

5000

6000

7000

8000

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15un

its0

50000

100000

150000

200000

250000

300000

|/un

it


On the volume front, VST’s tractor sales have grown at a CAGR of 20.2% in FY07-15 to 6694 units in FY15 (1537 units in FY07). On the realisation front, realisations have grown at a CAGR of 3.7% in FY07-15 to | 262922/unit in FY15 (| 197137/unit in FY07).

Market share in <30 hp segment; slowly inching upward VST is a prominent player in the low hp (<30 hp) tractor segment domestically with its market share increasing from a mere 2.7% in FY07 to 11.2% in FY15. These low hp tractors are meant primarily for agricultural operations and are not meant for any commercial activities like transportation of goods & personnel, etc. The major player in this segment is M&M with a market share of over 50%.

Exhibit 37: Domestic tractor market share – players (<=30 hp segment)

15.6 16.2 14.5 12.6 12.5 10.5 3.4 0.8 1.0

10.7 7.6 6.6 5.4 2.4 1.9 5.2 6.2 9.6

30.6 34.1 43.1 46.6 49.6 50.337.6

53.8 51.5

32.4 31.329.1 28.5 27.7 27.2

39.925.7 22.3

2.7 3.24.5 5.5 6.6 8.6 11.4 10.5 11.2

0102030405060708090

100


Escorts Force Motors International Tractors Ltd Mahindra & Mahindra Ltd TAFE VST

Source: Crisil, Company, ICICIdirect.com Research


Domestically, total tractor sales have grown at a CAGR of 7.3% in FY07-15 to 5.5 lakh units in FY15 (3.1 lakh units in FY07). Tractor sales in the <30 hp segment have largely remained flat and grew at a CAGR of 0.5% in FY07-15 to ~60,000 units in FY15. M&M is the market leader in this segment with a market share in excess of 50% while the second position is firmly held by TAFE with a market share of ~30%. The third position has been captured by VST with a market share of ~11%. Outperformance; within industry and segment VST has, on the whole, outperformed its industry and segmental growth rates in the recent past, which clearly showcases the company’s intent to become a prominent player in the domestic tractor business and increase its market share domestically.

Exhibit 38: Tractor sales growth (YoY)

-3.5

0.6

32.219.8

11.3

-1.7

20.2

-13.0-7.7 -3.7

33.7

4.714.6

-33.7

29.9

-15.5

11.5

35.8

61.5

26.0

48.6

-11.4

19.6

-10.2

-40

-20

0

20

40

60

80

FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

%

Total Tractor Sales Growth (YoY) Tractor Segment (<30hp) Sales Growth (YoY) VST Tractor Sales Growth (YoY)

Source: Crisil, Company, ICICIdirect.com Research

Tractor sales expected to grow at a CAGR of 14.3% in FY15-17E VST has recently undertaken a capex programme wherein it established a new tractor manufacturing facility in Hosur, Tamil Nadu with a capacity to manufacture 36,000 units annually (in two shifts per day). The company has also hired a new team headed by a new marketing manager wherein their prerogative is to record healthy sales growth (upward of 25%) in the tractor segment, going forward.

Exhibit 39: VST tractor sales (value)

154.4

194.3176.0

188.8

230.1

0

50

100

150

200

250


| cr

ore


Exhibit 40: VST tractor sales (volume & realisation)

6233 74

52

6694 73

63 9204

247714260668 262922 256349 249940

01000

20003000

40005000

6000700080009000

10000


no o

f uni

ts

0

50000

100000

150000

200000

250000

300000

| / u

nit



Going forward, we expect sales in this segment to grow at a CAGR of 14.3% in FY15-17E to | 230 crore in FY17E. Sales volumes are expected to grow at a CAGR of 17.3% in FY15-17E to 9204 units in FY17E. Realisations are expected to decline at a CAGR of 2.5% in FY15-17E primarily on the back of softer saw material prices.

Thus, it has been observed that apart from FY13 wherein there were some internal supply side issues within VST, the company’s tractor sales growth have always exceeded both the total industry growth rate as well its segmental growth rate, albeit on a lower base


Capacity in place; poised to benefit from demand revival VST has just recently concluded its capex programme wherein it has shifted its tractor facility out of its existing plant in Whitefield, Bengaluru to Hosur, Tamil Nadu. The company incurred a capex worth | 70 crore for the same that was entirely funded through internal accruals. VST’s current manufacturing capacity stands at 60,000 units for power tillers and 36,000 units for agricultural tractors, thereby implying a capacity utilisation of ~40% in case of power tillers (production ~24,000 units, capacity 60,000 units) and ~20% in case of agricultural tractors (production 7000 units, capacity 36000 units). Therefore, the company has surplus capacity and does not need any incremental capex at least in the next three to four years, going forward. VST is all poised to benefit from a revival in domestic demand in power tillers and tractors.

Exhibit 41: Capex spend (| crore)

16.67

5.73

10.4

31.5

36.5

22

10 10

0

5

10

15

20

25

30

35

40

FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E

| cr

ore


Going forward, on the back of no major capex plans, we have built in an operational capex amounting to ~| 10 crore/year for FY16E and FY17E. Strong FCF generation over FY15-17E; FCF yield to inch up to ~5% VST’s FCF generation was strong in FY14 wherein it generated FCF of ~| 100 crore. However, the same dropped to almost zero in FY15 primarily on the back of an increase in working capital (WC) on account of stress in the rural economy and capex on the new tractor facility.

Exhibit 42: VST FCF & FCF yield

14.5

99.7

-0.9

74.1

70.7

1.1

7.3

-0.1

5.5 5.2

-20

0

20

40

60

80

100

120


| cr

ore

-2.0

0.0

2.0

4.0

6.0

8.0

10.0%

FCF FCF Yield


Going forward, we expect VST to generate robust free cash flows (FCF) to the tune of ~ | 74 crore in FY16E and ~| 71 crore in FY17E primarily on the back of demand recovery, working capital improvement and minimal capex requirements.

FY13-15 were capex heavy years for VST wherein large sums of money were spent on establishing a tractor plant at Hosur (total capex at ~| 70 crore) vs. usual opex of | 10 crore per year

VST is expected to generate an FCF yield of ~5% in FY16E and FY17E

Major capex spend; FY3-15

VST has the potential to generate power tiller sales worth ~| 700 crore (FY15 sales at | 295 crore) and tractor sales worth ~| 800 crore (FY15 sales at | 176 crore) if it manages to ramp up capacity utilisation to 90%, translating to a total sales potential of ~ | 1500 crore (FY15 sales at | 550 crore)


Financials Revenues to grow at 13.7% CAGR in FY15-17E We expect VST to clock modest revenue growth at 13.7% CAGR in FY15-17E to | 710.8 crore in FY17E (| 550.1 crore in FY15). In the power tiller segment, revenues are expected to grow at a CAGR of 13.0% in FY15-17E to | 376.8 crore in FY17E (| 295 crore in FY15), primarily on the back of increasing farm mechanisation penetration domestically and as VST is best placed to capture the incremental demand in the power tiller segment. In the tractor segment, sales are expected to increase at a CAGR of 14.3% in FY15-17E to | 230 crore in FY17E (| 176 crore in FY15). This is primarily on the back of the management’s renewed focus on increasing its market share in the domestic tractor market post the commissioning of the new tractor manufacturing plant at Hosur, Tamil Nadu.

Exhibit 43: Consolidated revenue trend

481.7

624.2

550.1583.2

710.8

0

200

400

600

800


| cr

ore


Exhibit 44: Revenue break-up (power tillers and tractors)

260.6

342.5

295.0 309.2

376.8

154.4194.3

176.0 188.8230.1

0

100

200

300

400


| cr

ore

Power Tiller Sales Tractor Sales


FY15 was a subdued year for VST as revenues declined ~12% YoY primarily on the back of the subdued purchasing power of domestic farmers on account of muted cropping seasons and a delay in executing subsidy schemes on part of various state governments.

Exhibit 45: Revenue share mix (%)

54.3 55.0 53.6 53.0 53.0

32.2 31.2 32.0 32.4 32.4

13.6 13.8 14.4 14.6 14.6

0

20

40

60

80

100


%

Power Tillers Tractors others


The share of power tillers in the overall revenue mix is expected to moderate from 55% in FY14 to 53.0% in FY16E and FY17E, going forward. For the tractor segment, the same is expected to improve from 31% in FY14 to 32% in FY16E and FY17E, going forward.


EBITDA to grow at 11.4% CAGR in FY15-17E We expect EBITDA to grow at a CAGR of 11.4% in FY15-17E to | 124 crore in FY17E, primarily on the back of an increase in sales to the tune of 13.7% in the aforesaid period. EBITDA margins, however, are expected to moderate from 18.2% in FY15 to 16.5% in FY16E primarily on the back of VST passing on the benefits of lower raw material (steel) prices to its end customers and the competitive nature of the domestic power tiller and tractor industry. EBITDA margins are expected to improve 100 bps to 17.5% in FY17E as benefits of operating leverage start kicking in by virtue of increased sales out of the same fixed asset base i.e. better capacity utilisation levels (increased asset turnover).

Exhibit 46: EBITDA & EBITDA margins (%) trend

72.1

118.

9

100.

3

96.2 12

4.4

15.0

19.0 18.216.5 17.5

0

20

40

60

80

100

120

140


| cr

ore

0

5

10

15

20

25

%

EBITDA EBITDA Margin


Exhibit 47: Asset turnover Particulars Units FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17ESales | crore 344 425 531 482 624 550 583 711Gross Block | crore 79 84 90 114 164 184 196 206Asset Turnover x 4.3 5.1 5.9 4.2 3.8 3.0 3.0 3.5


PAT to grow at 12.9% CAGR in FY15-17E We expect PAT to grow at a CAGR of 12.9% in FY15-17E to | 88.6 crore in FY17E (| 69.5 crore in FY15) on the back of a pick-up in sales and moderation in EBITDA margins.

Exhibit 48: Consolidated PAT trend

48.6

82.9

69.5

66.8 88

.6

56.2

95.9

80.4 77.3

102.5

0102030405060708090

100


| cr

ore

0

20

40

60

80

100

120

|/sh

are

PAT EPS


Asset (gross block) turnover at VST has always stayed strong in the range of 3.0-5.9x in FY07-15 with the peak in FY12 wherein the asset turnover stood at 5.9x. The same in FY15 stood at 3.0x and is expected to improve to 3.5x by FY17E, thereby benefiting VST as the benefits of operating leverage start kicking in for the company


RoCE, RoE set to moderate, core RoICs set to improve after blip! On the back of a moderation in EBITDA margins and higher equity base, RoEs and RoCEs are set to decline, going forward. We expect RoCE to decline from 25.0% in FY15 to 23.3% in FY17E. The RoE is also expected to decline from 19.1% in FY15 to 18.2% in FY17E. The core RoICs are, however, set to improve from 31.0% in FY15 to 37.0% in FY17E primarily on the back of increasing capacity utilisation and corresponding sales and PAT, going forward.

Exhibit 49: RoIC, RoCE & RoE trend

28.1

36.8

25.020.5

23.3

19.9

26.5

19.116.0 18.2

31.4

52.8

31.0 29.7

37.0

0

10

20

30

40

50

60


%

RoCE RoE RoIC


Exhibit 50: EPS, DPS & dividend payout

56.2

95.9

80.4

77.3 10

2.5

9.0 15

.0

15.0

15.0 20

.0

16.1 15.6

18.7 19.4 19.5

0

20

40

60

80

100

120

FY13 FY14 FY15 FY16E FY17E|/

shar

e

0

5

10

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20

25

%

EPS DPS Dividend Payout


Dividend payout has been muted with the company’s average dividend payout in the last five years i.e. FY11-15 at ~17% despite a debt free and cash rich balance sheet. One logical reason for the same could be the planned expansion of the tractor facility. However, going forward, with the capex cycle behind it and no major expansion plans, the dividend payout may increase. However, we have built in conservative estimates due to the absence of a clear dividend policy. Going forward, we expect the company to record an EPS of | 77.3 in FY16E and | 102.5 in FY17E. The corresponding dividend is expected at | 15.0/share in FY16E and | 20.0/share in FY17E. Volatile working capital; build in conservative estimates As VST operates in a highly subsidy driven industry, WC at VST has been quite volatile with the five year average (FY11-15) net working capital days at 72 days. Going forward, we have built in conservative net working days at 85, 80 days in FY16E, FY17E, respectively. Exhibit 51: Net working capital days

92

47

9485

80

0

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40

60

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100


no o

f day

s



Risks & Concerns Erratic weather/bad monsoons As a farm equipment player, VST is not immune to the performance of south west monsoons, which affects the purchasing power of domestic farmers. In the past eight years, it has been observed that whenever there are below normal (rainfall at 90-96% of LP, FY13) or deficient monsoons (rainfall at <90% of LPA, FY15), the sales declined by an average 10%. FY10 was an exceptional year with robust sales (up 25% YoY) despite bad monsoons on account of the farm debt waiver scheme being implemented by the erstwhile UPA government. The drop in sales during sub-par monsoons is more severe in case of power tillers vis-à-vis tractors in the aforesaid period.

Exhibit 52: VST net sales sensitivity to south west monsoons

Power Tiller sales volume

Power tillers sales

Tractor sales volume

Tractor sales

Total Net Sales

YoY Growth Rainfall

Agri GDP at Constant Price

(2004-05) YoY

GrowthAgri GDP at

Current Prices YoY

Growth

Net sales growth/Agri GDP

Growth rate (units) (| crore) (units) (| crore) (| crore) % % from LPA | crore % | crore % %

FY07 10510 100 1537 30 162.3 100 523745 4.1 604672 12.6FY08 12174 118 1714 34 188.6 16.2 106 556956 6.3 716276 18.5 0.9FY09 16691 178 2327 50 274.1 45.3 98 555442 -0.3 806646 12.6 3.6FY10 19068 212 3758 81 344.5 25.7 78 557715 0.4 928586 15.1 1.7FY11 23449 267 4735 105 425.3 23.5 102 610905 9.5 1143517 23.1 1.0FY12 26154 301 7038 165 530.6 24.8 101 643543 5.3 1300569 13.7 1.8FY13 21231 261 6233 154 481.7 -9.2 92 649424 0.9 1417468 9.0 -1.0FY14 27252 342 7452 194 624.2 29.6 106 681412 4.7 1653802 16.7 1.8FY15 23104 295 6694 176 550.1 -11.9 88 NA 0.2 NA 4.4 -2.7

Fiscal Year


Therefore, going forward, any sub normal monsoon activity may limit the topline growth at VST and will have an adverse impact on the company’s profitability, thereby directly impacting our target price calculation. Volatility in raw materials prices, especially steel price Iron derivative products like pig iron, iron castings, stampings, metal sheets, etc. comprise the major raw material costs for power tillers & tractors with the management guiding that ~50% of the sales value is constituted by iron products (50%of sales equivalent to ~75% of raw material costs; raw material as a percentage of sales at ~65%).

Exhibit 53: Steel i.e. key raw material price sensitivity (FY17E numbers)

-10% -5% 5% 10%

RM as a % of Sales % 60.0 62.5 65 67.5 70.0

EBITDA Margins % 22.5 20.0 17.5 15.0 12.5

Change in PAT % 28.0 14.0 NA -14.0 -28.0

Change in EPS % 28.0 14.0 NA -14.0 -28.0

Target Price % 2101 1870 1640 1410 1179

Rise in Steel PriceDrop in Steel Price

UnitsParticulars Base Case

Source: ICICIdirect.com Research

We have modelled that steel price is a complete pass through for the company. However, any inability of the company to pass through the increase in steel costs will dent EBITDA margins and have a consequent negative impact on our target price calculation. Delay in subsidy execution & competition The domestic power tiller industry is highly subsidy driven with subsidy support @ 30-40% of the cost of equipment. Therefore, any delay in subsidy execution will dent its sales growth and working capital discipline. On the back of robust growth expected in the power tiller segment, it is possible that new players may enter the segment. This may increase the competition and dent the market share/volume for VST.

It has been observed that for every 5% increase in steel price and VST’s realisation remaining same; our target price reduces ~14.0% i.e. | 230/share


Valuation VST Tillers & Tractors (VST) is a farm equipment manufacturer wherein it manufactures power tillers and tractors at its facilities in Bengaluru and Hosur (Tamil Nadu), respectively. The company is a leading power tiller player domestically with total power tiller sales for FY14 at 27252 units (market share 48.7%). In FY15, however, tiller sales volumes came in lower at 23104 units. This was on the back of limited purchasing power of domestic farmers and a delay in subsidy scheme execution by some state governments. On the tractors front, VST is a strong player in the small agricultural tractors and manufactures tractors of <30 hp (sales at 6694 units in FY15, corresponding market share ~11%). The central government is focused on increasing farm mechanisation domestically while VST is extremely focused on maintaining its market share in the power tiller segment while at the same time increasing its market share in low hp tractors. Hence, we expect VST to clock sales and PAT CAGR of 13.7% and 12.9%, respectively, in FY15-17E. We have valued VST at | 1845, i.e. 18.0x P/E on FY17E EPS of | 102.5/share and assigned a BUY recommendation to the stock. VST is a debt free company with cash & cash equivalents of | 104 crore as of FY15. The company also boasts of superior return ratios with five year (FY11-15) RoCE and RoE at 32% and 24%, respectively. VST essentially qualifies as a portfolio stock with a long term investment horizon. Subdued monsoons, however, are a risk to our call since it tends to reduce the purchasing power of domestic farmers with a consequent drop in sales for agri input companies including VST Tillers & Tractors.

Exhibit 54: Two year forward P/E (VST currently trading at 15.3x)

0

200

400

600

800

1000

1200

1400

1600

1800

2000

Jan-

09

Jul-0

9

Jan-

10

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0

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Jul-1

1

Jan-

12

Jul-1

2

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13

Jul-1

3

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

(|)

Price 17x 14x 12x 10x 8x 5x 3x

Source: Reuters, ICICIdirect.com Research


Financial Summary Exhibit 55: Profit and Loss (| crore)

(Year-end March) FY13 FY14 FY15 FY16E FY17ENet Sales 481.7 624.2 550.1 583.2 710.8 Other Operating Income - - 1.5 - - Total Operating Income 481.7 624.2 551.6 583.2 710.8 Other Income 2.1 8.7 11.8 12.4 16.9 Total Revenue 483.8 632.9 563.5 595.6 727.7

Raw Material Expenses 329.6 411.1 357.1 379.1 462.0 Employee Expenses 28.1 36.0 40.6 46.7 53.3 Manufacturing Exp 49.3 55.3 53.7 61.2 71.1 Total Operating Expenditure 409.6 505.3 451.3 487.0 586.4

EBITDA 72.1 118.9 100.3 96.2 124.4 Interest 1.3 1.8 2.1 - - PBDT 72.9 125.8 110.0 108.6 141.3 Depreciation 3.4 3.9 9.4 10.4 11.1 PBT 69.6 121.9 100.6 98.2 130.2 Total Tax 21.0 39.0 31.2 31.4 41.7 PAT before MI 48.6 82.9 69.5 66.8 88.6 Minority Interest - - - - - PAT 48.6 82.9 69.5 66.8 88.6


Exhibit 56: Balance Sheet (| crore)(Year-end March) FY13 FY14 FY15 FY16E FY17EEquity Capital 8.6 8.6 8.6 8.6 8.6 Reserve and Surplus 235.8 303.5 354.9 409.4 477.7 Total Shareholders funds 244.4 312.1 363.5 418.0 486.3 Total Debt - - - - - Deferred Tax Liability 2.9 4.4 4.7 4.7 4.7 Minority Interest - - - - - Other Non Current Liabilities 18.6 26.1 31.7 36.7 41.7 Liability side total 266.0 342.6 399.9 459.4 532.7

Total Gross Block 113.6 163.9 183.9 196.0 206.0 Less Total Accumulated Depreciation 36.2 39.9 49.2 59.7 70.7 Net Block 77.4 124.0 134.7 136.3 135.3 Total CWIP 14.1 0.1 2.1 - - Total Fixed Assets 91.5 124.1 136.8 136.3 135.3 Other Investments 4.2 4.2 9.4 9.4 9.4 Liquid Investments - 102.1 85.8 145.8 195.8

Inventory 82.9 86.6 100.2 111.8 126.6 Debtors 97.3 102.3 93.9 103.9 126.6 Loans and Advances 26.9 27.6 27.3 26.2 28.4 Other Current Assets 0.2 0.5 0.4 0.6 0.7 Cash 32.9 22.5 18.4 25.3 30.8 Total Current Assets 240.2 239.5 240.2 267.8 313.1

Creditors 58.1 108.7 52.7 79.9 97.4 Provisions 11.8 18.5 19.5 20.0 23.4 Total Current Liabilities 69.9 127.2 72.2 99.9 120.7

Net Current Assets 170.3 112.3 168.0 167.9 192.3

Assets side total 266.0 342.6 399.9 459.4 532.7



Exhibit 57: Cash flow statement (| crore)

(Year-end March) FY13 FY14 FY15 FY16E FY17EProfit after Tax 48.6 82.9 69.5 66.8 88.6 Depreciation 3.4 3.9 9.4 10.4 11.1 Cash Flow before working capital changes 53.2 88.6 81.0 77.2 99.6

- - - - - Net Increase in Current Assets 6.1 (9.6) (4.9) (20.8) (39.8) Net Increase in Current Liabilities (13.3) 57.3 (55.0) 27.6 20.9 Net cash flow from operating activities 46.0 136.3 21.1 84.1 80.7

(Purchase)/Sale of Fixed Assets (31.5) (36.5) (22.0) (10.0) (10.0) Liquid Investments 20.2 (102.1) 16.3 (60.0) (50.0) Other Non Current Liabilities 4.3 7.5 5.6 5.0 5.0 Net Cash flow from Investing Activities (7.3) (129.6) (5.0) (65.0) (55.0)

Inc / (Dec) in Equity Capital - - - - - Inc / (Dec) in Loan Funds (16.0) - - - - Total Outflow on account of dividend (9.1) (15.2) (15.2) (15.2) (20.2) Net Cash flow from Financing Activities (26.4) (17.0) (20.2) (12.3) (20.2)

- - - - - Net Cash flow 12.4 (10.4) (4.1) 6.8 5.5 Cash and Cash Equivalent at the beginning 20.6 32.9 22.5 18.4 25.3 Closing Cash/ Cash Equivalent 32.9 22.5 18.4 25.3 30.8


Ratios

Exhibit 58: Ratio Analysis (Year-end March) FY13 FY14 FY15 FY16E FY17EPer Share DataEPS 56.2 95.9 80.4 77.3 102.5 Cash EPS 60.1 100.4 91.2 89.4 115.3 BV 282.9 361.3 420.7 483.8 562.9 Operating profit per share 83.5 137.6 116.1 111.4 144.0 Operating RatiosEBITDA / Total Operating Income 15.0 19.0 18.2 16.5 17.5 PAT / Total Operating Income 10.1 13.3 12.6 11.4 12.5 Return RatiosRoE 19.9 26.5 19.1 16.0 18.2 RoCE 28.1 36.8 25.0 20.5 23.3 RoIC 31.4 52.8 31.0 29.7 37.0 Valuation RatiosEV / EBITDA 18.4 10.4 12.5 12.3 9.1 P/E 28.0 16.4 19.6 20.3 15.3 EV / Net Sales 2.8 2.0 2.3 2.0 1.6 Sales / Equity 2.0 2.0 1.5 1.4 1.5 Market Cap / Sales 2.8 2.2 2.5 2.3 1.9 Price to Book Value 5.6 4.4 3.7 3.2 2.8 Turnover RatiosAsset turnover 1.9 2.1 1.5 1.4 1.4 Debtors Turnover Ratio 5.0 6.1 5.9 5.6 5.6 Creditors Turnover Ratio 8.3 5.7 10.4 7.3 7.3 Solvency Ratios

Debt / Equity - - - - - Current Ratio 3.4 1.9 3.3 2.7 2.6 Quick Ratio 2.3 1.2 1.9 1.6 1.5



Pseudo play on ‘Swaraj’ (M&M) brand... Swaraj Engines (SEL) is an engine manufacturer based in Mohali, Punjab). It serves the engine requirements of the Swaraj brand of tractors, owned by Mahindra & Mahindra (M&M). SEL manufactures engines catering to tractors in the 20-50 hp segment and caters to ~85% of the total engine requirement at M&M’s Swaraj tractor division. The company has a current installed capacity to manufacture 75,000 units of engines. SEL is in the midst of expanding its capacity to 105,000 units (to be commissioned by Q2FY16). Sales have grown at an impressive CAGR of 23.2% in FY08-15 to | 539.7 crore in FY15 (| 125.4 crore in FY08). Sales volumes (engines) have grown at a CAGR of 21.6% in FY08-15 to 64595 units in FY15 (16408 units in FY08). FY15, however, was a subdued year for SEL primarily on the back of low purchasing power of domestic farmers due to abnormal rains. Going forward, however, with the government’s thrust on increasing farm yields through increasing penetration of farm mechanisation and Swaraj tractor’s strong brand recall, SEL is on a strong footing. We expect sales and PAT to grow at a CAGR of 12.7% and 15.4%, respectively, in FY15-17E. SEL maintains a good payout ratio with average payout in the last three years at 72.7%. At the CMP, it offers an impressive dividend yield of ~4%. We have valued SEL at | 1110 i.e. 20x P/E on FY17E EPS of | 55.5 with a BUY rating on the stock. Indian tractor industry on strong footing; ‘Swaraj’ a prominent brand! The domestic tractor industry has been at the forefront of farm mechanisation penetration in India. Domestic tractor sales have increased at an impressive CAGR of 8.9% in FY08-15 to ~5.5 lakh units in FY15 (3.0 lakh units in FY08). FY15, however, was a subdued year for the domestic tractor industry (tractor sales at 5.5 lakh units, down 13% YoY) on the back of subdued agricultural activity due to abnormal rains in the last two cropping seasons. Swaraj is a prominent brand in the domestic market. It has a market share in excess of 10% within the ambit of its parent i.e. M&M, which has a combined market share of over 40% in the domestic tractor market. Going forward, on the back of the government’s thrust on increasing farm mechanisation, the parent’s focus on increasing the market share of Swaraj tractors and with timely capacity expansion in place, SEL is on a strong growth footing, going forward. Healthy financials; superior return ratios; re-rating warranted! SEL has a lean balance sheet with no debt on its books and cash & cash equivalents of | 180 crore as of FY15. The average RoCEs and RoEs in the last five years (FY11-15) at SEL are at 35% and 28%, respectively, backed by strong dividend payouts. The company is essentially a quality play and should be held in one’s portfolio with a long term investment horizon. Exhibit 59: Financial Performance

(Year-end March) FY13 FY14 FY15 FY16E FY17ENet Sales (| crore) 479.0 608.3 539.7 564.9 685.6 EBITDA (| crore) 71.4 90.6 74.7 82.2 103.1 Net Profit (| crore) 55.4 67.0 51.8 56.1 68.9 EPS (|) 44.6 53.9 41.7 45.2 55.5 P/E (x) 19.5 16.1 20.9 19.3 15.7 Price / Book (x) 5.6 5.1 5.1 5.0 4.7 EV/EBITDA (x) 13.0 10.0 12.0 11.0 8.6 RoCE (%) 33.2 38.8 29.0 31.5 38.6 RoE (%) 28.6 31.9 24.4 25.8 30.2


Rating Matrix

Rating : BuyTarget : | 1110Target Period : 12-18 monthsPotential Upside : 28%

YoY Growth (%) (YoY Growth) FY14 FY15 FY16E FY17ENet Sales 27.0 (11.3) 4.7 21.4 EBITDA 26.9 (17.6) 10.1 25.4 Net Profit 21.0 (22.7) 8.4 22.8 EPS (Rs) 21.0 (22.7) 8.4 22.8

Valuation Summary

FY14 FY15 FY16E FY17EP/E 16.1 20.9 19.3 15.7 Target P/E 20.6 26.6 24.6 20.0 EV / EBITDA 10.0 12.0 11.0 8.6 P/BV 5.1 5.1 5.0 4.7 RoNW 31.9 24.4 25.8 30.2 RoCE 38.8 29.0 31.5 38.6

Stock Data Stock DataMarket Capitalization | 1080.5 CroreTotal Debt (FY15) | 0 Crore

Cash and Investments (FY15) | 181.9 CroreEV | 898.6 Crore52 week H/L 1073 / 742Equity capital | 12.4 CroreFace value | 10MF Holding (%) 9.2FII Holding (%) 6.8

Price Performance Return % 1M 3M 6M 12MSwaraj Engines 18.3 7.3 4.8 (0.4) M & M 6.1 0.9 3.6 5.6

Price Movement

0

200

400

600

800

1,000

1,200

Jul-15Nov-14Apr-14Aug-13Jan-13Jun-12

2,0003,0004,0005,000

6,0007,000

8,0009,000

10,000

Price (R.H.S) Nifty (L.H.S)

Research Analysts

Chirag J Shah [email protected] Shashank Kanodia [email protected]

Swaraj Engines (SWAENG)| 870


Company background SEL is a joint holding of Kirloskar Industries (17.4% stake) and M&M (33.2% stake) with M&M the main promoter consequent to its acquisition of Punjab Tractors in 2007-08. The Government of India originally set up the company in 1985 for manufacturing diesel engines for Punjab Tractors, which marketed their products under the Swaraj brand. SEL commenced production at its facility in Mohali in 1988 and has been a profitable entity since then. Since inception, the company also had a technical collaboration with Kirloskar Industries (KIL) that also bought ~17% stake in SEL, thereby partnering with SEL in all its technical, designing and functional needs. However, from 2005-06, the company has ended its technical collaboration with KIL and developed in-house capability & facilities for modernisation and technological upgradation of its products. SEL also ropes in some consultancy firms as and when the need arises but does not have a fixed collaboration with any other major player in the industry. The company does not pay any royalty to either of its promoter companies viz. M&M and KIL. SEL manufactures engines catering to tractors in the 20-50 hp segment and is currently in the process of developing an engine for the >50 hp segment. The company also manufactures hi-tech engine components for commercial vehicles for SML Isuzu (erstwhile Swaraj Mazda). The contribution to the topline, however, remains limited (<3%).

Exhibit 60: Engine sales; hp break-up

41-50 hp40%

31-40 hp50%

<=30 hp10%


As far as segmental sales are concerned, SEL manufactures ~10% engines catering to the <=30 hp tractor segment, ~50% engines catering to the 31-40 hp tractor segment and ~40% engines catering to the 41-50 hp tractor segment. SEL’s margins vary across the hp segment with margins more accretive in the higher hp segment.

Exhibit 61: Sales segmentation (FY15)


Net Sales | 540 crore in FY15

Engines | 525 crore in FY15

(97.2%)

Engine Components

| 2 crore in FY15 (0.4%)

Spare and Others | 13 crore in FY15

(2.4%)

Shareholding pattern (%) – Q4FY15

Shareholder's Category Holding (%)

Promoters 50.6

Institutional Investors 16.0

General Public 33.4

FII & DII holding trend (%)

1.5 1.9 1.92.5

3.2

5.56.2

6.8

10.6 10.4 10.5 10.3 10.810.1

9.5 9.2

0.0

2.0

4.0

6.0

8.0

10.0

12.0

Q1FY

14

Q2FY

14

Q3FY

14

Q4FY

14

Q1FY

15

Q2FY

15

Q3FY

15

Q4FY

15

%

FII DII

FII & DII - Major Shareholders (%) – Q4FY15

Shareholder's Category Holding (%)

Pinebridge Investments Asia Ltd 3.2

DSP Blackrock Micro Cap Fund 1.9

Franklin India Smaller Comp. Fund 1.6

National Westminster Bank PLC 1.4

SBI Magnum Midcap Fund 1.3

HDFC Small & Midcap Fund 1.2

Total net sales in FY15 stood at | 540 crore with majority i.e. ~97% comprising engines


Investment arguments Domestic tractor market on strong footing; penetration set to increase The domestic tractor industry has been at the forefront of farm mechanisation in India with tractor sales increasing at a CAGR of 7.3% in FY07-15 to ~5.5 lakh units in FY15 (3.1 lakh units in FY07). Within segments, main growth was witnessed in the segment of 41-50 hp, which has grown at a CAGR of 17.5% to 2.6 lakh units over FY07-15 (70 thousand units in FY07). This reflects the preference of tractors for farming as well as other allied services like haulage of construction material and personnel. On the other hand, sales of small hp tractors i.e. <= 30 hp & 31-40 hp, which are primarily meant for agricultural activities, have grown at a CAGR of 0.5% & 2.5%, respectively, in FY07-15. Exhibit 62: Domestic tractor sales

Category FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15FY 07-15

CAGR<= 30 hp 57669 53208 51214 68477 71721 82224 54506 70811 59866 0.531-40 hp 166400 153338 152941 194488 214348 244431 233397 223302 202497 2.541-50 hp 70342 73004 71414 94183 137180 143102 199130 308810 256270 17.5>=50 hp 19530 23398 29053 45438 59037 67134 40735 31228 32830 6.7Total 313941 302948 304622 402586 482286 536891 527768 634151 551463 7.3

Source: Crisil, ICICIdirect.com Research

Exhibit 63: Domestic tractor sales (segmental share)

18.4 17.6 16.8 17.0 14.9 15.3 10.3 11.2 10.9

53.0 50.6 50.2 48.344.4 45.5

44.2 35.2 36.7

22.4 24.1 23.4 23.4 28.4 26.7 37.7 48.7 46.5

6.2 7.7 9.5 11.3 12.2 12.5 7.7 4.9 6.0

0

20

40

60

80

100


%

<= 30 hp 31-40 hp 41-50 hp >=50 hp


In terms of composition, robust growth was seen in the 41-50 hp segment (17.5% CAGR in FY07-15) leading to significant market share gains of 2400 bps to 46.5% in FY15 from 22.4% in FY07. On the other hand, maximum drop in market share was observed in the 31-40 hp segment wherein the percentage share dropped 1600 bps to 36.7% in FY15 from 53.0% in FY07.

Going forward, on the back of subdued purchasing power of domestic farmers due to the last two muted cropping seasons, domestic tractor demand growth is expected to be negative in H1FY16E. Growth is expected to pick up in H2FY16 if south west monsoon 2015 is fairly widespread and normal in nature. Long term growth of the domestic tractor industry is, however, pegged at 8-10% (as per industry estimates) till FY19E primarily on the back of the government’s thrust on increasing crop yields through greater farm mechanisation, increasing penetration of tractors in low tractor density states mainly southern & western regions, replacement demand from high tractor density states (mainly the northern region) and a pick-up expected in domestic construction industry. This will increase tractor demand for haulage/commercial usages (non-farm usage comprises ~30% of tractor demand domestically).


Domestic tractor penetration; lower than global peers The penetration of tractors is low in India in comparison to other developed and developing countries with domestic penetration at a mere 0.8 hp/hectare vs. 9.8 hp/hectare in West Germany and 4.1 hp/hectare in China. This, however, provides an opportunity of growth for the domestic tractor industry, which has miles to go before it reaches its summit. This bodes well for all tractor manufacturers domestically.

Exhibit 64: Tractor penetration across the globe (2011)

9.8

8.27.6

7

4.5 4.1 4.1 3.7

2 1.9 1.8 1.6 1.60.8

0

2

4

6

8

10

12

Wes

tGe

rman

y

Italy UK

Japa

n

Fran

ce

Sout

h Ko

rea

Chin

a

Pola

nd

USA

Turk

ey

Kore

a

Thai

land

Viet

nam

Indi

a

hp/h

ecta

re


Southern, western regions to provide next leg of growth Tractor penetration is robust in the agrarian belt of northern region mainly Punjab, Haryana & Uttar Pradesh. The domestic tractor penetration, however, is low in the agrarian belt of southern and western India mainly Andhra Pradesh, Tamil Nadu & Maharashtra.

Exhibit 65: Domestic agricultural characteristics - Regional Cropping Intensity Irrigation Penetration M&M Market Share Tractor Market

2011-12 (%) 2011-12 (%) FY15 (%) OutlookNorthern RegionPunjab 191.2 98.3 37.5 NeutralHaryana 184.7 87.5 33.9 NeutralUttar Pradesh 155.3 76.7 37.5 Neutral to positiveRajasthan 135.9 36.3 28.5 PositiveSouthern RegionAndhra Pradesh 123.3 49.3 46.8 PositiveTamil Nadu 118.1 59.7 53.5 PositiveKarnataka 121.3 34.3 45.6 PositiveWestern RegionMaharashtra 126.1 18.7 45.6 PositiveMadhya Pradesh 147.8 36.5 34.6 PositiveGujarat 127.1 48.2 44.5 PositiveChattisgarh 121.1 29.1 46.0 PositiveEastern RegionBihar 141.7 67.4 45.2 Neutral to positiveWest Bengal 179.9 58.1 50.8 PositiveOrissa 113 28.9 51.3 PositiveAll India 138.7 46.9 40.3

Region


Therefore, low penetration of tractors in the southern & western regions and the government’s thrust on increasing farm productivity, particularly in the eastern states, bodes well for the domestic tractor industry. Thus, good tractor sales growth is expected, going forward, which should benefit domestic manufacturers.


Mahindra & Mahindra leader domestically with dominant market share Mahindra & Mahindra (M&M) is the market leader in the domestic tractor market with a market share in excess of 40% in FY15, way above its nearest competitor that has a market share of ~24% (TAFE). M&M has grown its domestic tractor portfolio both organically as well as inorganically with market share gains of ~1000 bps from 30.3% in FY07 to 40.3% in FY15. As far as segmental market share is concerned, M&M is also the market leader in all segments (<= 30 hp, 31-40 hp, 41-50 hp) except >=50 hp segment (segmental share at 6.0% of overall tractor sales) wherein the pole positioned is occupied by TAFE.

Exhibit 66: Domestic tractor market share - Players

14.1 14.6 13.5 13.2 13.2 11.4 11.6 10.7 10.4

11.3 9.8 8.9 8.7 8.6 8.3 9.6 10.3 12.0

3.7 4.4 6.0 7.0 8.0 7.4 5.7 5.9 5.3

30.3 29.741.6 41.6 42.2 41.8 40.6 41.0 40.3

8.0 9.20.0 0.0 0.0 0.0 0.0 0.0 0.0

23.7 23.4 22.2 22.1 20.4 23.4 25.0 24.8 24.4

4.6 3.6 2.4 2.7 2.5 2.5 2.4 2.2 2.4

0

20

40

60

80

100


%

Escorts Ltd International Tractors Ltd Johndeere Mahindra & Mahindra Ltd New Holland India Punjab Tractors Ltd. TAFE others


On the inorganic front, M&M had acquired Punjab Tractors (PTL) way back in FY08. The erstwhile PTL owned the Swaraj brand, which was ultimately acquired by M&M. M&M has over the years capitalised on the brand recall of Swaraj and grown its portfolio.

Swaraj - Trusted tractor brand; outperformance warranted!

Exhibit 67: Domestic tractor sales- total and Swaraj Particulars Units FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15Total Tractor Sales unit 313941 302948 304622 402586 482286 536891 527768 634151 551463YoY Growth % 18.6 -3.5 0.6 32.2 19.8 11.3 -1.7 20.2 -13.0

Swaraj Engine Sales unit 17702 16408 28539 39143 47413 55239 57377 74062 64595Market Share % 5.6 5.4 9.4 9.7 9.8 10.3 10.9 11.7 11.7YoY Growth % -7.3 73.9 37.2 21.1 16.5 3.9 29.1 -12.8

Total Swaraj Tractor Sales* unit 25115 27871 33575 46051 55780 64987 67502 87132 75994Market Share % 8.0 9.2 11.0 11.4 11.6 12.1 12.8 13.7 13.8YoY Growth % 11.0 20.5 37.2 21.1 16.5 3.9 29.1 -12.8

Source: Crisil Research, Company, ICICIdirect.com Research *Total Swaraj volume calculated by keeping share of SEL engines for Swaraj Tractors constant at 85% (Post FY08)

The market share of the Swaraj brand of tractors has increased from 9.2% in FY08 to 13.8% in FY15 implying a gain in market share of ~460 bps over a seven period. SEL i.e. Swaraj Engines is the supplier of engines (meets ~85% of engine requirements) for the Swaraj brand of tractors.

Thus, on the back of a trusted promoter group that has a dominant market share in the domestic tractor industry market, renewed focus on increasing the market share of the Swaraj brand of tractors with SEL supplying ~85% of engine requirements at Swaraj tractors, SEL is on a strong footing. Hence, it is poised for a robust growth journey ahead.

Sales growth of Swaraj tractors has also exceeded the industry growth rate in all previous years i.e. FY08-15. Even in the years of negative volume growth rates for the industry i.e. FY08 & FY13, volumes of Swaraj tractors recorded positive sales volume growth. In FY15, on the back of a subdued demand scenario amid subdued purchasing power of domestic farmers, volumes at Swaraj brand de-grew 12.8% vs. industry de-growth of 13.0%


SEL: expanding capacities; sales & profitability to follow Post acquisition by M&M (i.e. post FY08), SEL has always operated at optimal capacity utilisation levels with utilisation levels at 96.2% (average) in FY10-15. During the aforesaid period, the company has undertaken three expansion programmes wherein it first increased its capacity from 36,000 units to 42,000 units in FY11, then to 60,000 units in FY12 and then finally to 75,000 units in FY13. All capacity additions were undertaken under the supervision of the main promoter group i.e. M&M as and when M&M sensed the greater demand for the Swaraj brand of tractors.

Exhibit 68: SEL: Capacity, production & capacity utilisation trend

3600

0

3600

0

3600

0

3600

0

4200

0

6000

0

7500

0

7500

0

7500

0 1050

00

1050

00

1770

6

1641

7

2872

8

3925

4

4801

5

5509

9

5734

8

7478

6

6399

4

6760

9

8113

0

49.2 45.6

79.8

109.0 114.3

91.8

76.5

99.7

85.3

64.477.3

0

20000

40000

60000

80000

100000

120000

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E

units

0

20

40

60

80

100

120

140

%

Capacity Production Capacity Utilization


In FY14, the company achieved 100% capacity utilisation level (capacity: 75,000 units, production: 74,786 units) and could sense the greater demand for the Swaraj brand of tractors. Hence, SEL undertook an expansion plan wherein the company is expanding its capacity from 75,000 units to 105,000 units at a cost of | 38 crore (to be completed by Q2FY16). SEL also undertakes continuous innovation and technology upgradation to meet the changing engine requirements at the Swaraj division at M&M. The company is also developing engines in the >50 hp segment that will further help augment sales at SEL. All expenses for the aforesaid expansion were undertaken from internal accruals.

Exhibit 69: SEL: Sales volume and realisation trend

1770

2

1640

8

2853

9

3914

3

4741

3

5523

9

5737

7

7406

2

6459

5

6760

9

8113

0

60615 6167765840 65503 69559

75019 78481 79636 81344 81344 82564

0

20000

40000

60000

80000

100000

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E

units

0

20000

40000

60000

80000

100000

|/un

it



Going forward, we expect sales volumes at SEL to grow at a CAGR of 12.1% in FY15-17E to 81130 units in FY17E. We have assumed de-growth of 20% in H1FY16 and a pick-up in demand in H2FY16 so as to end FY16E with a marginal volume growth rate of 5%. FY17E volume growth is expected at 20.0%. On the realisations front, given subdued steel prices, we have estimated flattish realisations.

As per media sources, M&M plans to launch six new tractor variants in the next three years in the domestic market, with the launch equally spread between M&M and Swaraj Tractors. New product launches in the Swaraj division bode well for SEL with incremental engine requirements at the Swaraj tractor division to be met by SEL


Working capital - key hallmark of SEL! SEL, after being acquired by M&M, has drastically improved its working capital cycle with net working capital days reducing from 42 days in FY08 to four days in FY09. Thereafter, the net working capital has either been marginally negative or zero thereby implying prudent capital management at SEL. This has resulted in strong cash flow generation for the company with five year average CFO: EBITDA at 0.9x in FY11-15.

Exhibit 70: SEL: Net working capital days (break-up)

25 2226

36

2730 28

22

30 30

49

95

8 107 5 5 5 5

3227

3742 43

38 38 36 35 35

0

10

20

30

40

50

60

FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E

days

Inventory Days Debtor Days Creditor Days


Exhibit 71: SEL: Net working capital days

42

4

-6

2

-6-1

-5-9

0 0

-20

-10

0

10

20

30

40

50

FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E

no o

f day

s


Conservatively, going forward, we have assumed nil net working days in FY16E and FY17E. Superior return ratios; excellent dividend yield!! The return ratio profile for SEL has been superior with five year average RoCEs and RoEs at 35% and 28%, respectively in FY11-15. Going forward, on the back of a pick-up in tractor (Swaraj) demand/capacity expansion and consequent engine sales at SEL, we expect return ratios to inch up in FY16E and FY17E. The core return ratio i.e. RoICs has, however, been above 100% post acquisition by M&M with five year average RoICs at 219% in FY11-15.

Exhibit 72: RoIC, RoCE & RoE trend

33.2 38

.8

29.0

31.5 38

.6

28.6 31

.9

24.4

25.8 30

.2

150.6

214.4194.0

146.4

219.3

0

10

20

30

40

50


%

0

50

100

150

200

250

%

RoCE RoE RoIC


Exhibit 73: EPS, DPS & dividend payout

44.6 53

.9

41.7 45.2 55

.5

33.0

35.0

33.0

35.0 40

.074.0

64.9

79.2 77.472.1

0

10

20

30

40

50

60


|/sh

are

0

20

40

60

80

100

%

EPS DPS Payout Ratio


Dividend payout at SEL has been excellent with the company’s average dividend payout in the last five years (FY11-15) at ~55%. Since FY13, SEL has been paying dividend per share in the range of | 33-35/share primarily on the back of a debt free, cash rich balance sheet and absence of any major capex plans. We expect this healthy dividend to continue, going forward. This is primarily on the back of no major need for cash as the ongoing capex programme is on the verge of completion, with dividend/share expected at | 35/share & | 40/share in FY16E & FY17E, respectively, thereby offering an attractive dividend yield of ~4-5%.


Financials Revenues to grow at 12.7% CAGR in FY15-17E We expect SEL to clock modest revenue growth at 12.7% CAGR in FY15-17E to | 685.6 crore in FY17E (| 539.7 crore in FY15). We expect sales volumes of engines at SEL to grow at a CAGR of 12.1% in FY15-17E to 81130 units in FY17E (64595 units in FY15). On the realisations front, we expect realisations to remain largely flat in FY15-17E with marginal growth of 1% in the aforesaid period, primarily on the back of softer raw material prices (mainly iron & steel products).

Exhibit 74: Sales trend

479.0

608.3539.7 564.9

685.6

-

100

200

300

400

500

600

700

800


| cr

ore


We have assumed sales volume de-growth of 20% in H1FY16 primarily on the back of a muted industry commentary amid subdued purchasing power of domestic farmers and sluggish construction activity domestically. For H2FY16, we expect sales volumes to pick up strongly at ~45%, albeit on a small base, primarily on the expectation of normal monsoons (present fear of below normal monsoons are slowly receding with monsoon, till date, in the current season at -4% of LPA vs. -12% of LPA for the overall last monsoon season). For full year FY16E, we expect sales volume growth at ~5% i.e. 67609 units. We expect sales volume growth of 20% in FY17E. This would primarily be on the back of increasing sales of Swaraj Tractor in low tractor density regions domestically and new product launches by parent (M&M) under the Swaraj brand. The consequent engine demand would flow down to SEL.

Exhibit 75: Sales volume and realisation

5737

7

7406

2

6459

5

6760

9

8113

078481

79636

81344 81344

82564

0

20000

40000

60000

80000

100000


units

76000

77000

78000

79000

80000

81000

82000

83000

|/un

it



Exhibit 76: Quarterly sales volume & YoY growth

1603

5

1604

3

1701

4

1851

6

1924

2

1925

2

2041

7

2221

9

-20 -20

4050

20 20 20 20

0

5000

10000

15000

20000

25000

Q1FY

16E

Q2FY

16E

Q3FY

16E

Q4FY

16E

Q1FY

17E

Q2FY

17E

Q3FY

17E

Q4FY

17E

units

-30-20-100102030405060

%

Sales Volume YoY Grwoth



EBITDA to grow 17.5% CAGR in FY15-17E We expect EBITDA to grow at a CAGR of 17.5% in FY15-17E to | 103.1 crore in FY17E (| 74.7 crore in FY15), primarily on the back of sales growth (12.9% CAGR) and improvement in EBITDA margins to the tune of 120 bps to 15.0% in FY17E (13.8% in FY15). SEL does not benefit from a drop in raw material prices as raw material costs are completely pass through for the company. However, operational efficiencies on the back of better capacity utilisation levels/asset turnover will be the main drivers for an improvement in EBITDA margins, going forward.

Exhibit 77: EBITDA & EBITDA margins (%) trend

71.4 90

.6

74.7 82.2 10

3.1

14.9 14.9

13.8

14.5

15.0

-

20

40

60

80

100

120


| cr

ore

13

14

14

15

15

16

%

EBITDA (| crore) EBITDA Margin (%)


Exhibit 78: Asset turnover trend Particulars Units FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E

Gross Block | crore 67.5 70.1 71.3 71.9 77.6 96.0 141.5 152.9 163.4 178.4 188.4

Sales | crore 129.0 125.4 208.2 282.4 360.7 448.6 479.0 608.3 539.7 564.9 685.6Asset Turnover x 1.9 1.8 2.9 3.9 4.6 4.7 3.4 4.0 3.3 3.2 3.6


PAT to grow at 15.4% CAGR in FY15-17E We expect PAT to grow at a CAGR of 15.4% in FY15-17E to | 68.9 crore in FY17E (| 51.8 crore in FY15) on the back of a pick-up in sales (12.7% CAGR in FY15-17E) and improvement in EBITDA margins (120 bps over FY15-17E). We expect EPS at | 45.2/share and | 55.5/share in FY16E and FY17E, respectively.

Exhibit 79: Consolidated PAT trend

55.4 67

.0

51.8

56.1 68

.9

44.6

53.9

41.745.2

55.5

-

10

20

30

40

50

60

70

80


| cr

ore

-

10

20

30

40

50

60

|/sh

are

Net Profit (| crore) EPS (|)


Asset (gross block) turnover at SEL has always stayed strong in the range of 1.8-4.7x in FY07-15 with the peak being in FY12 wherein the asset turnover was at 4.7x. The same in FY15 was at 3.3x. It is expected to improve to 3.6x by FY17E, thereby benefiting SEL as the benefits of operating leverage start kicking in for the company


Cash flows to remain robust; FCF yield to inch towards ~6%

By virtue of following prudent working capital management norms, the cash generation at SEL is healthy with CFO to EBITDA at 1.0x in FY15. Going forward, we expect SEL to realise healthy cash flows with CFO-EBITDA averaging at ~0.8x over FY15-17E. On the free cash flow (FCF) front, the company is on the verge of completing its existing capex programme (amounting to | 38 crore). SEL is expected to report robust FCF, going forward. We expect SEL to record FCF of | 45.8 crore in FY16E and | 75.6 crore in FY17E, thereby generating a healthy FCF yield of ~6% over FY15-17E.

Exhibit 80: CFO, EBITDA, CFO-EBITDA trend

88.8

84.0

71.1

56.0

85.6

71.4 90

.6

74.7 82.2 10

3.1

1.2

0.9 1.0

0.70.8

0

20

40

60

80

100

120


| cr

ore

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

x

CFO EBITDA CFO :EBITDA


Exhibit 81: Free cash flow, free cash flow yield

49.1

72.4

55.0

45.8

75.6

6.7

5.1

4.2

7.0

0

20

40

60

80

100


| cr

ore

0.0

2.0

4.0

6.0

8.0

%

FCF FCF Yield



Risks & Concerns Erratic weather/bad monsoons may lead to demand volatility

As SEL is a proxy play on farm mechanisation domestically, the company is not immune to the performance of the south west monsoons, which affects the purchasing power of domestic farmers. It has been observed that in case of below normal or deficient monsoons, the sales volume growth of SEL is adversely impacted. In FY13, when monsoons were below normal at 92% of LPA, sales growth was muted at 3.9% compared to healthy double digit growth witnessed in the past. In FY15, when monsoons were deficient (88% of LPA), SEL witnessed sales volume de-growth of 13%, thereby showing its vulnerability to south west monsoons.

Exhibit 82: SEL net sales sensitivity to South West Monsoons

Engine Sales Volume YoY Growth Net sales YoY Growth Rainfall

Agri GDP at Constant Price

(2004-05) YoY

GrowthAgri GDP at Current

Prices YoY

Growth

Net sales growth/Agri GDP

Growth rateunits % | crore % % from LPA | crore % | crore % x

FY07 17702 129 100 523745 4.1 604672 12.6

FY08 16408 -7.3 125.4 -2.8 106 556956 6.3 716276 18.5 -0.2

FY09 28539 73.9 208.2 66.0 98 555442 -0.3 806646 12.6 5.2

FY10 39143 37.2 282.4 35.6 78 557715 0.4 928586 15.1 2.4

FY11 47413 21.1 360.65 27.7 102 610905 9.5 1143517 23.1 1.2

FY12 55239 16.5 448.57 24.4 101 643543 5.3 1300569 13.7 1.8

FY13 57377 3.9 479 6.8 92 649424 0.9 1417468 9.0 0.8

FY14 74062 29.1 608.3 27.0 106 681412 4.7 1653802 16.7 1.6

FY15 64595 -12.8 539.7 -11.3 88 NA 0.2 NA 4.4 -2.6

Fiscal Year


Therefore, going forward, any sub-par monsoon activity may impact volume growth of SEL. It will have an adverse effect on the profitability, thereby directly impacting our target price calculation.

Volatility in raw materials prices, especially steel price

Iron derivative products like pig iron, iron castings, stampings, metal sheets, etc. form the major raw material costs for engines with the management guiding that ~100% of the raw material costs comprise iron products that are equivalent to 75% of sales value.

Exhibit 83: Steel i.e. key raw material price sensitivity (FY17E numbers)

-5.0% -2.5% 2.5% 5.0%

RM as a % of Sales % 71.3 73.1 75 76.9 78.8

EBITDA Margins % 18.8 16.9 15 13.1 11.3

Change in PAT % 26.0 13.0 NA -13.0 -26.0

Change in EPS % 26.0 13.0 NA -13.0 -26.0

Target Price % 1396 1253 1110 967 824

Rise in Steel Price

Particulars Units

Drop in Steel Price

Base Case

Source: ICICIdirect.com Research

We have modelled steel price to be a complete pass through for the company. However, any inability of the company to pass through the increase in steel costs will dent EBITDA margins and have a consequent negative impact on our target price calculation. Competition Though M&M is the leader in the tractor market domestically and has grown the Swaraj brand well over the past few years, if competition is fierce that can impact sales of Swaraj tractors. Consequently, this may impact SEL’s engine sales volume and dent the profitability of SEL.

It has been observed that for every 2.5% increase in steel price and SEL’s realisation remaining same, our target price reduces ~13.0% i.e. | 143/share

SEL witnessed good sales volume growth in FY10 despite deficient monsoon (78% of LPA) on account of farm debt waiver being implemented by the erstwhile UPA government.


Valuation With timely expansion programmes (FY11; capacity increased from 36,000 units to 42,000 units; then to 60,000 units in FY12 and then finally to 75,000 units in FY13) coupled with increasing market share of the Swaraj brand of tractors (increased from 9.2% in FY08 to 13.8% in FY15) and SEL being present in all major tractor hp segments, SEL is on a strong footing. The company has a prominent role to play in the increase of farm mechanisation domestically. Consequently, sales have grown at an impressive CAGR of 23.2% in FY08-15 to | 539.7 crore in FY15 (| 125.4 crore in FY08) wherein its sales volume (engines) have grown at a CAGR of 21.6% in FY08-15. FY15, however, was a subdued year for SEL primarily on the back of the low purchasing power of domestic farmers due to abnormal rains. Going forward, however, with the government’s thrust on increasing farm yields through increasing penetration of farm mechanisation and Swaraj tractor’s strong brand recall, SEL is on a strong footing. We expect sales and PAT to grow at a CAGR of 12.7% and 15.4%, respectively, in FY15-17E. SEL has a lean balance sheet with no debt on its books and cash & cash equivalents of | 180 crore as of FY15. Average RoCEs and RoEs were at 35% and 28%, respectively, in the last five years (FY11-15). SEL also has good payout ratios with average payout in the last three years at 72.7% with FY15 dividend at | 33/share (dividend yield ~4%). By virtue of following prudent working capital management norms, the cash generation at SEL is healthy with CFO to EBITDA at 1.0x in FY15. Going forward, we expect SEL to realise healthy cash flows with CFO-EBITDA averaging at ~0.8x over FY15-17E and FCF yields to inch towards ~6%. We have valued SEL at | 1110 i.e. 20x P/E on FY17E EPS of | 55.5 and assigned a BUY recommendation to the stock. With fears of below normal monsoons receding and as the company is a proxy play on the farm mechanisation theme in India, Swaraj Engines is essentially a quality play and should be held in one’s portfolio with a long term investment horizon.

Exhibit 84: Two year forward P/E (SEL currently trading at 15.7x)

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5

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9

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(|)

Price 17x 15x 14x 12x 10x 8x 6x

Source: Reuters, ICICIdirect.com Research


Financial Summary Exhibit 85: Profit and Loss (| crore)

(Year-end March) FY13 FY14 FY15 FY16E FY17ENet Sales 479.0 608.3 539.7 564.9 685.6 Other Operating Income - - - - - Total Operating Income 479.0 608.3 539.7 564.9 685.6 Other Income 15.3 17.5 16.3 15.2 14.8 Total Revenue 494.3 625.8 556.0 580.2 700.4

Raw Material Expenses 364.5 462.3 409.1 423.7 514.2 Employee Expenses 22.1 27.7 30.8 33.8 38.4 Manufacturing Exp 21.0 27.7 25.1 25.3 29.9 Total Operating Expenditure 407.6 517.7 465.0 482.7 582.5

EBITDA 71.4 90.6 74.7 82.2 103.1 Interest 0.1 0.0 0.0 0.0 0.0PBDT 86.6 108.1 91.0 97.4 117.9 Depreciation 7.2 9.1 13.2 13.7 15.0 PBT 79.5 97.8 77.8 83.8 102.9 Total Tax 24.1 30.8 26.0 27.6 34.0 PAT 55.4 67.0 51.8 56.1 68.9


Exhibit 86: Balance Sheet (| crore)(Year-end March) FY13 FY14 FY15 FY16E FY17EEquity Capital 12.4 12.4 12.4 12.4 12.4 Reserve and Surplus 181.3 197.4 199.7 204.9 215.8 Total Shareholders funds 193.8 209.8 212.1 217.4 228.2 Total Debt - - - - - Deferred Tax Liability 6.3 6.9 6.3 6.3 6.3 Minority Interest - - - - - Other Non Current Liabilities - - - - - Liability side total 200.1 216.8 218.4 223.7 234.5

Total Gross Block 141.5 152.9 163.4 178.4 188.4 Less Total Accumulated Depreciation 60.8 68.9 79.6 93.2 108.3 Net Block 80.8 84.1 83.8 85.2 80.1 Total CWIP 2.5 1.7 4.8 - - Total Fixed Assets 83.3 85.8 88.6 85.2 80.1

Investments 74.2 72.2 42.0 52.0 67.0

Inventory 39.3 46.4 33.1 46.4 56.3 Debtors 9.3 7.9 6.9 7.7 9.4 Loans and Advances 14.2 12.4 9.2 10.2 12.3 Other Current Assets - 4.6 5.6 5.6 6.9 Cash 80.7 104.9 139.9 124.8 127.3 Total Current Assets 143.5 176.1 194.7 194.8 212.2

Creditors 50.0 63.0 53.0 54.2 65.7 Provisions 50.9 54.3 53.9 54.2 59.2

Total Current Liabilities 100.9 117.3 106.9 108.3 124.9

Net Current Assets 42.6 58.8 87.7 86.5 87.3

Assets side total 200.0 216.8 218.4 223.7 234.5



Exhibit 87: Cash flow statement (| crore)

(Year-end March) FY13 FY14 FY15 FY16E FY17EProfit after Tax 55.4 67.0 51.8 56.1 68.9 Depreciation 7.2 9.1 13.2 13.7 15.0 Cash Flow before working capital changes 62.6 76.1 65.0 69.8 84.0

Net Increase in Current Assets (0.8) (8.5) 16.5 (15.2) (14.9) Net Increase in Current Liabilities 26.9 16.4 (10.4) 1.4 16.6 Net cash flow from operating activities 88.8 84.0 71.1 56.0 85.6

(Purchase)/Sale of Fixed Assets (39.7) (11.6) (16.1) (10.2) (10.0) Liquid Investments 6.9 2.0 30.2 (10.0) (15.0) Net Cash flow from Investing Activities (29.7) (9.0) 13.5 (20.2) (25.0)

Inc / (Dec) in Equity Capital - - - - - Total Outflow on account of dividend (48.0) (50.9) (49.3) (50.9) (58.1) Inc / (Dec) in Loan Funds - - - - - Net Cash flow from Financing Activities (48.1) (50.9) (49.6) (50.9) (58.1)

Net Cash flow 11.0 24.2 35.0 (15.0) 2.5 Cash and Cash Equivalent at the beginning 69.7 80.7 104.9 139.9 124.8 Closing Cash/ Cash Equivalent 80.7 104.9 139.9 124.8 127.3


Ratios Exhibit 88: Ratio Analysis

(Year-end March) FY13 FY14 FY15 FY16E FY17EPer Share DataEPS 44.6 53.9 41.7 45.2 55.5 Cash EPS 50.3 61.2 52.3 56.2 67.6 BV 156.0 169.0 170.8 175.0 183.7 Operating profit per share 57.5 72.9 60.1 66.2 83.0 Operating RatiosEBITDA / Total Operating Income 14.9 14.9 13.8 14.5 15.0 PAT / Total Operating Income 11.6 11.0 9.6 9.9 10.1 Return RatiosRoE 28.6 31.9 24.4 25.8 30.2 RoCE 33.2 38.8 29.0 31.5 38.6 RoIC 150.6 214.4 194.0 146.4 219.3 Valuation RatiosEV / EBITDA 13.0 10.0 12.0 11.0 8.6 P/E 19.5 16.1 20.9 19.3 15.7 EV / Net Sales 1.9 1.5 1.7 1.6 1.3 Sales / Equity 2.5 2.9 2.5 2.6 3.0 Market Cap / Sales 2.3 1.8 2.0 1.9 1.6 Price to Book Value 5.6 5.1 5.1 5.0 4.7 Turnover RatiosAsset turnover 2.5 2.9 2.5 2.6 3.0 Debtors Turnover Ratio 51.5 77.5 78.6 73.0 73.0 Creditors Turnover Ratio 9.6 9.7 10.2 10.4 10.4 Solvency Ratios

Debt / Equity - - - - - Current Ratio 1.4 1.5 1.8 1.8 1.7

Quick Ratio 1.0 1.1 1.5 1.4 1.2



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Pankaj Pandey Head – Research [email protected]

ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC, Andheri (East) Mumbai – 400 093

[email protected]


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