On Friday, BofA Securities adjusted its outlook on Escorts (NS:ESCO) Kubota Ltd (ESCORTS:IN), reducing the price target to INR3,250 from the previous INR3,600. The firm sustained its Underperform rating on the stock. The adjustment follows the conclusion of the merger between Kubota India subsidiaries (KAI & EKI) in the reported quarter, which impacted the company's financials.
The merger resulted in a decline of Escorts Kubota's EBIT margin to 9.1%, a notable decrease from the pre-merger range of 11-12%. While the margin dilution aligns with some expectations, the extent of the decrease was significant. The management of Escorts Kubota anticipates an EBIT margin normalization to 12-13% over the next 12 to 18 months, banking on product and cost improvements, as well as synergies from the merger.
The combined revenue of KAI & EKI, the merged subsidiaries, stood at Rs30B in F24, with a modest EBIT margin of approximately 2%, compared to Escorts' pre-merger EBIT margin of 11.4%. The overall reported Q2 EBIT for Escorts, including the merged business, showed a decline of 2% year-over-year even when adjusted for comparability. This was compounded by less than impressive earnings in the railways and construction equipment segments, which saw a 20% year-over-year decrease.
The analyst highlighted the importance of engine localization for Kubota products as a critical factor in achieving mid-teen margin levels. However, this is a long-term goal expected to take three to four years, as it is contingent on the development of a new greenfield plant, which has yet to begin.
In light of the recent financial performance and the challenges ahead, the valuation of Escorts Kubota stock at 32 times F26 earnings is seen as leaving little room for further disappointments, leading to the reiterated Underperform rating.
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