We downgrade our stance on both Tractor stocks from Buy to Neutral, as margins are expected to remain under pressure amid elevated commodity prices, `expected decline in wheat and other crops in FY23.
In light of present macroeconomic scenario, we now assume slower industry sales dragged by multiple price hikes, looming water shortage before the Kharif crop season, low fertilizer inventory and threat of GST hike in the FY23 Budget (without an offsetting subsidy for farmers).
The average FY23f DY of 10% for the two stocks is lower than PIB yields (plus the above risks). Our new TP for MTL is PKR950/sh (rolled-over to Jun 2023) and that of AGTL is PKR405/sh (Dec 2022).
Not a very conducive environment for tractor sales…
We downgrade both Tractor stocks in our coverage from Buy to Neutral, with new rolled-over TP of PKR950/sh for MTL (Jun 2023) and PKR405/sh for AGTL (Dec 2022). This is backed by downward estimate revisions which stem from: (i) sequentially declining margins despite over 90% localization for the industry, because of elevated input costs, (ii) greater liquidity strain amid pile up of GST refund claims, (iii) lower volumetric sales amid sharp price hikes (15-20% since June 2021), and (iv) moderating farmer income amid potential shortfalls in production of major crops. We also highlight that the present fiscal weakness may warrant GST hikes for the industry (IMF demand) without the cushion of subsidies to keep prices constant, in our view. Historically, even a 5% hike in the rate was followed by a c.30% fall in volumes in following year, as seen in FY12 and FY14.
…hence we cut our earnings estimates
We cut our earnings estimates for the two Tractor stocks by an average c.5% for 2023/2024f, in light of (i) sequentially declining margins amid rise in prices of steel and other inputs (despite high localization), (ii) lower than previously estimated industry volumes, (iii) uncertainty with regards to major crop production amid missed targets for wheat and potentially greater water shortage prior to the Kharif season and (iv) dwindling fiscal space to provide further support to the agri-sector in the upcoming Budget, in our view. Also, potentially moderating crop prices is another factor for the expected slowdown in tractor volumes. Our new 2023/24f sales assumptions for MTL and AGTL are c.36,500/37,500 and 16,000/16,500 units respectively. We have also trimmed our gross margins by an average 3ppt for FY22/24f. However, a potential reversal in dynamics affecting farmer income remains possible due to the importance of the sector both economically and politically,. Further incentives to boost agriculture production (and increase of minimum support prices) cannot be ruled out, in our view. Also, increased focus on lending to farmers at subsidized rates is likely to bolster farm dynamics.
We would prefer MTL over AGTL, when conditions improve
Despite generously high payouts – averaging over 90% of earnings in the past 5yrs – and FY23f DY of c.10% (average), emerging pressures on future sales dampen our liking for the sector. We highlight that in spite of slightly higher DY for AGTL compared with that of MTL, we prefer the latter due to greater certainty of payouts and stable management (AGTL management has changed frequently over the last couple of years), diversification into the Autos sector (SUV sales still healthy) and focus on exports. We will become more positive on the sector if the government announces an incentive package for farmers, potentially before the next general elections (if global commodity prices correct and allow more fiscal space to the government), and if the government refrains from increasing GST on tractors.