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Punjab Tractors: Topline woes continue

Feb 2, 2006

Performance Summary
Punjab Tractors had announced its 3QFY06 results earlier this week. To sum up, the performance was disappointing. Not only did the topline register a mere 3% YoY growth, higher operating expenses resulted in margin contraction. At the PBT level, an increase in interest expense resulted in 4% YoY decline in the profits before tax. But for the a reduction in effective tax rate by 230 basis points, the performance at the net profit level would have been worse. The net profits decline by 1% YoY during the third quarter.

(Rs m) 3QFY05 3QFY06 Change 9MFY05 9MFY06 Change
Net sales 2,510 2,575 2.6% 6,227 7,076 13.6%
Expenditure 2,133 2,210 3.6% 5,458 6,198 13.6%
Operating profit (EBDITA) 377 365 -3.2% 769 878 14.2%
EBDITA margin (%) 15.0% 14.2% 12.3% 12.4%
Other income 0 0 43 44 2.3%
Interest (net) 14 18 28.6% 52 51 -1.9%
Depreciation 40 38 -5.0% 120 116 -3.3%
Profit before tax 323 309 -4.3% 640 755 18.0%
Extraordinary item - - 0 613
Tax 113 101 -10.6% 222 285 28.4%
Profit after tax/(loss) 210 208 -1.0% 418 1,083 159.1%
Net profit margin (%) 8.4% 8.1% 6.7% 15.3%
No. of shares (m) 60.8 60.8 60.8 60.8
Diluted earnings per share (Rs)* 21.0
Price to earnings ratio (x) 11.5
(* trailing twelve months)

What has driven the performance in 3QFY06?
Another quarter of underperformance: Punjab Tractors has been losing market share since FY01. To give a perspective, the company’s market share, which stood at 18% in FY01, reduced to 12% in FY05. This trend has continued in the current fiscal as well, primarily on account of increasing competition from more vibrant players like M&M and Sonalika. In the current fiscal (till date), M&M has clocked more than 25% YoY growth. This has affected the market share of Punjab Tractors and the company has continued to under perform the industry growth as well.

Operating margins – a contrarian show: During 3QFY06, the automobile majors have reported improvement in their operating margins. However, Punjab Tractors has registered an 80 basis points decline. Not only the company has failed to reap the benefits of declining steel prices but its other operating expenses have also increased significantly. This could be attributed to increasing competition as a result of which the company may be offering higher incentives to its dealers and customers.

Cost break-up…
(Rs m) 3QFY05 3QFY06 %Change 9MFY05 9MFY06 %Change
Raw materials 1,830 1880 2.7% 4,503 5,274 17.1%
% sales 72.9% 73.0% 72.3% 74.5%
Staff cost 175 187 6.9% 515 552 7.2%
% sales 7.0% 7.3% 8.3% 7.8%
Other expenses 128 143 11.7% 440 409 -7.0%
% sales 5.1% 5.6% 7.1% 5.8%

Tax saves the day: The profit before taxes declined at much faster pace of 4% YoY as compared to decline in the operating profits. This is primarily attributed to a sudden increase in interest expense. However, we prefer to view interest expense over a longer period as a particular payment liability in a quarter can give a misleading picture. For the nine-month period, interest expense has declined by 2% YoY. A significant reduction in the tax outgo (as evident by a 230 basis points reduction in effective tax rate) has enabled the company to restrict the impact of a sudden jump in the interest expense in 3QFY06. For 9mFY06, the growth in net profit is largely owing to an extraordinary income of Rs 613 m arising out of stake sale in one of the group companies.

What to expect?
At the current price of Rs 242, the stock is trading at price to cash flow multiple of 20.4 times our estimated FY06 earnings (excluding extraordinary income), which is on the higher side of the valuation band. As stated earlier, the company has been losing market share over past five years. Apart from this, there appears to be some kind of conflict in the management prevailing currently. This has directly affected the performance in the current fiscal. The 9mFY06 performance has been below our initial estimates and hence we might have to re-look at our numbers.

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