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Punjab Tractors: A rewind - Views on News from Equitymaster
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Punjab Tractors: A rewind
Jun 20, 2005

Last week, we had written an article on Punjab Tractors stating the key assumption for the next three years – for the industry as well for Punjab Tractors. In this article, we consider the performance of the company over the last five years, which will have an influence on determining how the company is likely to fare in the near future.

Background
Punjab Tractors Limited (PTRA), promoted by Punjab State Industrial and Development Corporation (PSIDC) came into existence in 1970. IN FY03, CDC acquired PDISC’s stake in the divestment process. PTRA is one of the leading manufacturers of tractors in India with a market share of 12% in FY05. It has presence across all the segments of tractor industry, bifurcated on basis of horse power (HP). It products stable consists of 9 tractors models ranging from 25HP to above 40HP. It also manufactures agricultural accessories like harvester combined and forklifts. Tractors contribute around 90% of its sales and are marketed under brand name ‘Swaraj’.

Industry
The prospects of tractor industry are directly linked to timeliness, quantum and distribution of monsoon, government policies like minimum support price, food grain procurement and quantum of imports. In India agriculture is subjected to the vagaries of the monsoon, which has been erratic over the years. Infact, the period of FY99-FY03 has been the one of the worst phases with draught-like situation faced in most of the parts of the country. This directly impacted the agriculture output and the fortune of the tractor industry.

Last five years performance…
(Rs m) FY01 FY02 FY03 FY04 FY05 CAGR
Volumes sold ('000s) 45,712 40,100 24,200 25,607 30,330 -9.7%
Net sales 9,645 8,882 5,579 5,973 8,580 -2.9%
Total revenues 9,719 8,960 5,641 6,033 8,630 -2.9%
Operating profit 1,827 1,693 1,004 757 1,139 -11.1%
Operating margin 18.9% 19.1% 18.0% 12.7% 13.3%  
Depreciation 169 177 170 165 160 -1.4%
Interest 53 158 165 98 58 2.2%
Profit before tax 1,679 1,436 730 554 972 -12.8%
Tax 555 435 191 133 343 -11.3%
Profit after tax 1,125 1,000 538 420 629 -13.5%
Net profit margin 11.7% 11.3% 9.7% 7.0% 7.3%  
Fully Diluted EPS (Rs) 18.5 16.5 8.9 6.5 10.4  

As can be seen from the table above, the company has posted a decline in both sales and net profit in the last five years. However, the decline in volume sales is much higher at 10% CAGR. Not only has the industry been affected by erratic monsoons, but also due to the fact that the industry went through a inventory correction phase (there was a significant capacity build-up because of new competitors entering the market. Production levels were higher even as demand for tractor was lackluster, which led to inventory pile-up at the dealer level. At peak, the industry inventory was as high as nine months of sales. The manufacturers had to correct this anomaly and this partly reflects the decline in sales in the last five years). Though PTRA has shown a sharp rise in sales in FY05, operating margins and net margins were significantly lower than what it was in FY02. The net margins in FY02 were higher in spite of significantly higher levels of interest outgo.

Spiraling employee cost:  Though employee cost shows a modest 7% CAGR for the period FY99-FY05, it is in the backdrop of reduction in number of employees over the period from 2,800 in FY99 to 2,251 in FY05 (11% CAGR increase in staff cost per employee). During this period, the sales per employee recorded a mere 2% CAGR, thereby putting significant pressure on the operating margins. During the same period, raw material costs to sales increased from 68% of sales in FY01 to 72% of sales in FY05, on the back of the steep rise in steel prices. Going forward, we expect staff cost to be at these levels.

Liquidity crunch:  During the period FY99-FY02, the industry had been through a difficult phase of oversupply, unreasonable industry practices and poor demand. Punjab Tractors has also suffered with total volumes decelerating from a high of 50,705 units in FY00 to 30,330 units in FY05. That said, the company went overboard and resorted to credit sales to maintain its topline, which significantly affected its cash position. As a result of which it had to borrow funds resulting in increased interest obligation (refer table above). Going forward, we feel that there is no guarantee that the industry would not resort to such credit selling especially when the operating levels of the industry are to the tune of 60%

Falling returns:  As can be seen from the chart, both return on networth (RONW) and return on capital employed (ROCE) have been falling in spite of no significant increase in capital expenditure. However, a heartening fact was that the proportion of debt in FY05 stood at mere 4% of total assets.

Going Forward
Though, with the governments thrust on rural infrastructure, awareness and education of farmers together with easy availability of finance the tractor industry is witnessing a structural change, the benefits of the same will be reaped over a longer period of time. In next two to three years, we believe that the competition from existing players is likely to increase, given the fact that industry is operating at significantly lower level of capacity utilisation and there are plans to scale up production. This can affect the pricing power and thereby, restrict margin improvement. Apart from this, additional promotional and publicity expenditure will be required to maintain existing market share.

At current price of Rs 180, the stock is trading at price to earnings multiple of 13.5 times our FY07 estimates, which appears to be over valued in comparison to its peers like M&M.

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