Equity Analysis /
Pakistan

Weak agricultural outlook warrants caution

    Intermarket Securities
    17 September 2018
    • We resume coverage on Pakistan tractors with an Underweight stance where negatives for this sector arise from (i) increased input costs for farmers (such as Urea prices), (ii) possible water shortage resulting in lower crop output and (iii) slowing construction activities.
    • Based on the abovementioned reasons, we expect tractor volumes to decline by 5/2% in FY19/20F. We are Neutral on MTL with Jun’19 TP of PKR1,190/sh and have a Sell stance on AGTL with Dec’19 TP of PKR535/sh.
    • We prefer MTL (Neutral) over AGTL (Sell) due to former’s 18% stake in Hyundai Nishat Motors and room for exports. AGTL has also recently started exports to Afghanistan and introduced new CBU products for the local market, but these developments are not material, in our view.

    Multiple risks for Pakistan’s tractor industry: We foresee multiple risks for Pakistan tractors over the next 2-3 years arising from (i) increased input cost for farmers, (ii) risk of water shortage in the upcoming winter sowing season and (iii) slowdown in construction activities. Urea, which accounts for c.30% of farmer input costs, has seen c.10% yoy price hike where increase in gas prices can push it even higher. Moreover, media reports suggest that water shortage could be severe for winter harvesting season (Rabi) as well. To recall, cotton production target has already been revised downwards by 25% (from 14.37 mn bales to 10.85, implying 6% decline over FY18 production) as lower water availability led to decline in Sindh’s sowing area. Slowdown in construction activities (due to cut in federal development expenditure) will also lead to lower tractor demand, in our view, as they are used for commercial haulage purposes.

    We also do not see material subsidy schemes by either Sindh or Punjab until the next election cycle. In their absence, it will be difficult to sustain peak tractor sales (71,877 units in FY18, up 31% yoy, highest since FY10 sales of 71,607 units). In addition, potential increase in GST on tractors (from current 5%) presents a major risk. However, the current government will likely not take such a decision, in our view.   

    Millat Tractors: Exports and auto venture are possible triggers: We are Neutral on Millat Tractors (MTL) with a Jun’19 TP of PKR1,190/sh offering 4% upside along with 9% dividend yield. While we believe that expected decline in tractor volumes will affect MTL proportionately, MTL appears to be more diversified than AGTL due to i) access to a wider export market and ii) 18% equity stake in Hyundai Nishat Motors which is expected to roll out Hyundai branded vehicles in FY20. While it has been widely reported that prices of local tractors are the cheapest in the world and MTL has met environmental standards via its “green tractors”, exports may still take 2-3 years to pick up materially due to (i) branding/prices being controlled by AGCO (brand owner of Massey Ferguson) and (ii) competition with Chinese/Indian made tractors. We expect gross margins for MTL to settle at 24/23% during FY19/20F vs 26% in FY18. 

    The stock currently trades at FY19/20F P/E of 9.8/9.5x, against last 10yr average of 8.7x. As we have not incorporated auto venture stake as yet, greater clarity on this investment can make us more bullish on the company.

    Al Ghazi Tractors: Dividend yield to normalize: We have a Sell stance on Al-Ghazi Tractors (AGTL) with Dec’19 TP of PKR535/sh which implies 9% downside from last closing with 8% dividend yield. AGTL has 40% market share and is mainly focused on Pakistan market, where we foresee a challenging scenario. Last year, the company received access from its brand owner, CNH Italia, to Afghanistan, which is not a large market, in our view. AGTL also introduced few CBU products (combine-harvester, baler and 98 Hp tractor) earlier this year but we see limited market for such products amidst challenging agricultural outlook. Our gross margin assumption for CY18/19F stands at 25/23% vs 28% in CY17.

    AGTL trades at CY19/20 P/E of 10.9/10.4x, significantly higher than last 10yr average of 8.4x, due to higher payouts, in our view. However, going forward we see normalized payout ratio (90%) as cash balances are now significantly lower.

    Downside Risks: (i) increase in GST on tractors, (ii) significant decline in agricultural output and (iii) entry of new tractor assembler.

    Upside Risks: (i) tractor subsidy by new government and (ii) more than expected increase in exports.