Jul 9, 2004|
Tractors: Is the buoyancy justified?
Tractor manufacturers were one of the biggest beneficiaries from yesterday's budget. And not without reason. Apart from indirect benefits in the form of sops to the farming community, the FM in one fell swoop, brought down the excise duties on tractors to zero and thus handed out double bonanza to tractor companies. Ever since, despite the markets being knocked off their perches, tractor stocks have witnessed significant buying interest. But we believe that before being gung-ho about the entire event, a look at the fundamentals of the companies is in order so that one can ascertain whether the buoyancy is for real or not.
The tractor industry in FY04 came out of a three-year slump and witnessed a volume growth of 11%. Therefore in the backdrop of good monsoon expectations for the current year and increased benefits to the farming community as announced in the budget, we expect the buoyancy to continue for the current year also. Therefore, while the growth in volumes will not be a problem for the tractor companies, how much of it is already in the valuations? Let us try and find out.
We have made an attempt to track the growth prospects of two leading companies viz. M&M and Punjab Tractors for the current fiscal. The table below enlists two different scenarios. The possible earnings at the end of FY05 and a valuation metric, P/E during the same period before the budget announcement and after the announcement. If we assume that the companies pass on half the excise benefit to the consumers, then taking an appropriate demand elasticity (we have assumed that with every 1% fall in prices, demand goes up by 1.2%), our estimates suggest that following would be the impact.
But the moot point is that how much of this is already there in the valuations? We believe that tractor being linked to overall economic growth, it should command valuations not more than a couple of percentage points higher than the growth in GDP, which we believe should be in the region of 6%-7% during the current fiscal. Both the companies that we considered should however deserve a small premium over others by way of their leadership position and comparatively better margins. Taking these aspects and the stock appreciation of the last two days into consideration, caution has to be exercised because the valuations might have already reached the higher end of the spectrum.
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