Escorts stock has gained 9 per cent since Monday following the announcement of its joint venture (JV) with Japans Kubota to manufacture high-end products. The gain was over and above the 3.5 per cent drop in the stock price soon after the JV was announced. The fall reflected markets concern over the possibility of margin dilution after the JV. However, the company management clarified the doubts during an investors call on Tuesday, which resulted in the positive sentiment towards the stock.
Kubota will have equity participation of 60 per cent in the JV to set up a plant with a capacity of 50,000 units per year for a total investment of Rs 300 crore. Of this, Escorts will invest Rs 120 crore and also provide the land. Each of the companies will have a dedicated capacity with some flexibility.
The markets fear of margin reduction emanated from the possibility of higher payment by Escorts on each tractor procured from the JV. However, it was put to rest after the management clarified that no top-up margin on such tractors will be paid. In addition, the cost difference between the JV production and Escorts tractors will be reduced by the earnings from leasing the land to the JV.
A major benefit of the JV is that Escorts will add more capacity at lower capital expenditure. Currently, the capacity utilisation of Escorts plants is over 80 per cent. Given the massive cyclicality in the tractor volumes, contract manufacturing will help the company minimise business risk during the phase of low demand. Also, during a rising demand scenario, it can quickly ramp up production by increasing the proportion of its requirement from the JV.
The JV production will be mainly catering to the high-end (more than 40 HP) segment and in the later stage can be used for lowerend tractors. Kubota will benefit from low-cost manufacturing as it sales nearly 10,000 units a year in India, which are imported currently from Thailand and Japan.
Escorts will also be able to increase exports given the access to Kubotas global distribution network. Escorts exported 2,000 units in FY18. It plans to export 8,000-10,000 units by FY22. Indian companies exported nearly 80,000 tractors in FY18. Exports grew 6.4 per cent annually in the past five years. Typically, the realisation from exports is higher compared with that of domestic sales.
The joint venture will develop new products for the Indian and export market. echnical expertise by manufacturing globally competitive products. The co-developed products may focus on 30-50 HP segment to target southern marts of India where Escorts has a low market share.
At Wednesdays closing price of Rs 657.6 on the BSE, the companys stock was traded at 12.5 times the earnings in the next four quarters compared with the five-year average of 13.7.