Swaraj Engines Research Report By ICICI-Direct

Best placed to play “agriculture theme”

• Swaraj Engines (SEL) is a leading manufacturer of engines supplying to the Swaraj brand of tractors

• It predominantly supplies engines in the 20-50 hp tractor segment

• It is a direct beneficiary of robust tractor sales domestically with Swaraj brand tractor commanding a promising ~17% market share as of FY17, up from ~12% as of FY12 (up 500 bps over five years)

• With the industry leader reporting 44% growth in domestic tractor sales in Q4FY18 we expect this robust performance to percolate down to SEL With the government’s focus on augmenting farm income through increase in MSP, early indications of normal & widespread monsoon 2018, infrastructure activity on the uptick (employs ~30% of tractor) and incremental capacity expansion under execution (105 KT to 120 KT), we believe SEL is the most efficient play on agriculture theme domestically with robust sales & PAT prospects, going forward

• SEL has successfully completed the buyback programme wherein it bought 2.95 lakh shares @2400/share, total spend of ~| 71 crore

Skymet forecasts monsoon 2018 at 100% of LPA; SEL to benefit

Skymet, a private weather forecasting agency, expects the upcoming monsoon 2018 to be normal at 100% of LPA with a +/- 5% model error. On a month wise distribution, they expect June to be 111% of LPA, July at 97% of LPA, August at 96% of LPA and September at 101% of LPA.

The most encouraging part of the prediction was the 80% probability of a normal to above normal monsoon and no chance of a drought like scenario.

This is likely to result in robust farm production and consequent increase in farm income, boosting rural demand, thereby benefiting all farm mechanisation companies, including SEL.

Domestic tractor industry records new high in FY18E, on firm footing!

The domestic tractor industry has been at the forefront of farm mechanisation in India. Tractor sales in FY18E have surpassed a previous high (6.3 lakh units) with annual sales at ~7 lakh units (up 20% YoY).

The industry leader, has further consolidated its position with annual sales at ~3 lakh units implying a market share of 43.3%, up 50 bps YoY.

With government’s focus on augmenting farm income and early signs of normal monsoon 2018, the domestic tractor industry is on a firm footing with robust FY19E prospects (growth to taper albeit on high base).

Strong brand recall, capital efficiency at its very best; retain BUY

Swaraj tractors have a strong brand recall, which translated to ~500 bps increase in its market share over a five-year period to ~17% in FY17.

The larger acceptance of Swaraj brand of tractors is primarily on the back of balanced design, low cost of ownership over the lifecycle of product, robust service network and fuel efficiency among others.

We expect Swaraj Brand to continue outperforming the domestic tractor industry with consequent benefits flowing down to SEL.

SEL has a healthy balance sheet with no debt on its books, negative working capital cycle and robust return ratios amid healthy dividend payouts (~75%).

Post buyback (utilisation of surplus cash on books), its return ratios have further improved with average RoCE, RoE & RoIC over FY18-20E is at 56%, 41% & 290%, respectively. Going forward, with macro drivers in place, we expect SEL to clock engine sales volume CAGR of 14.0% in FY17-20E to 121392 units in FY20E (82297 units in FY17).

We expect sales, PAT to grow at a CAGR of 15.4%, 15.9%, respectively, in FY17-20E. We value SEL at | 2500 i.e. 30x P/E on FY19E & FY20E average EPS of | 84 with a BUY recommendation on the stock.