VST Tillers Tractors ltd (NSE Code VSTTILLERS) - Katalyst Wealth Alpha Recommendation

VST Tillers Tractors Ltd (NSE Scrip Code – VSTTILLERS)Tilling its way through small agriculture land holdings!!Tilling its way through small agriculture land holdings!!

www.katalystwealth.com

Alpha/Alpha Plus stock recommendation for Dec’11

Content Index

• An Introduction :- Slide #3

• Business Overview :- Slide #7

• Earnings estimate for FY 2015 (E) :- Slide #18

• Management Quality :- Slide #21

• Industry Overview :- Slide #25

• Financial Overview :- Slide #32

• Concerns :- Slide #37

• Conclusion :- Slide #39


VST Tillers Tractors Ltd – An Introduction


VST Tillers Tractors Ltd, from the illustrious VST group, was incorporated in the year 1967 in Bangalore, India intechnical collaboration and joint venture with Mitsubishi Heavy Industries and Mitsubishi Corporation, Japan for themanufacture of Power Tillers and Diesel Engines.

In 1984, VST entered into an additional technical and financial collaboration with Mitsubishi Agricultural Machinery

Largest Tiller manufacturer in India

In 1984, VST entered into an additional technical and financial collaboration with Mitsubishi Agricultural MachineryCompany Ltd, Japan for the manufacture of 18.5 HP, 4 wheel drive Tractor.

The manufacturing plant of the company is located in Whitefield Industrial area near Bangalore. It has 75,000 Sq.meters of land and a built up area of 15,000 Sq. meters (approx). The company is coming up with a secondmanufacturing plant in Hosur.

The main products of the Company are Power Tillers and Tractors:

• In the space of Power Tillers, VST commands a leadership position with a market share of 45%.• In the segment of tractors, VST was amongst the first few companies to have introduced a <20 HP tractor, while

other companies are now following in the footsteps.


Investment Snapshot (As on December 30, 2011)

Recommendation :- BUY1st Accumulation Range:- 400-415 (2% allocation)2nd Accumulation Range:- 330-350 (3% allocation)1st Profit Booking :- Sell 30% at Rs 7002nd Profit Booking :- Hold remaining for further updates through Alpha Weekly

Current Market Price – Rs. 417.00

BSE Code – 531266 NSE Code – VSTTILLERS

Bloomberg Code – VSTT:INBloomberg Code – VSTT:IN

Market Cap (INR Crores) – Rs 351 crores

Total Equity Shares [Mn] – 8.63

Face Value – Rs. 10

52 Week High / Low – Rs. 580.00 / Rs. 404.00

Promoter’s Holding – 53.91%


Key Investment highlights

Low farm mechanization in India– There’s no denying that availability of adequate farm power is very crucial fortimely farm operations for increasing production and productivity and the power productivity relationship showsthat those States having higher farm power availability/ha have higher productivity.

Small land holdings in India apt for the growth of Tillers and small tractors - Out of about 105 million farmers whoown land in India, about 80 million are small and marginal farmers, who are witnessing labor scarcity and risingwages. For most of these farmers, the medium 31-40 HP tractors are too expensive and too big for their farms,while Low HP tractors and tillers are affordable, making them a viable option.

Capacity expansion with internal accruals – For the last many years, VST has been consistently generating positivecash flows which has enabled it to pile on sufficient cash for carrying out a Rs 100 crore capacity expansion. Thecash flows which has enabled it to pile on sufficient cash for carrying out a Rs 100 crore capacity expansion. Thesame will more than double the current combined (tillers + tractors) production capacity of the company. It isexpected to come on stream in Sep’12.

Consistently earning high return on shareholder’s funds – Over the longer term, the company can grow only as fastas it generates returns on the funds employed. VST has consistently been earning 25%+ return on equity for the last5 years. Considering the capacity expansion that the company has embarked on, we expect far better utilization offree cash and liquid investments, thus expecting the company to further improve upon current capital utilization.

Very attractive valuations – VST Tillers is a debt free company with a very strong track record. At current levels, thestock is available at 7-7.5 times FY 12 (E) earnings and 1.75 times the FY 12 (E) book value. A 10-15% correctionfrom current levels will take it towards the lowest end of valuation parameters the stock has witnessed in the pastand we have thus suggested a 2 phase buying strategy, considering the overall negative bias in the markets.


Business Overview

• Major Products• Main revenue streams• Sales realization per Power tiller and Tractor• Sales realization per Power tiller and Tractor• Margins – Pricing power and Economies of Scale• Power Tillers – Overview• Tractors – Overview• Production capacity & Utilization• Country wide dealer network• Strong product pull• Consistently earning high return on Shareholder’s funds


Major products !!

18.5 HP Tractor Power Tiller


18.5 HP Tractor Power Tiller

Rice Transplanter Engines

Main revenue streams• For VST there are two major revenue streams: Power

Tillers and Tractors. Though VST commands more than45% market share in the Power Tillers segment, it couldstill record an impressive annualized growth of 27%against an average industry growth of 18-20%, thusthwarting Chinese imports.

• The growth in Tractors segment is even morespectacular at 35% CAGR, however low base has alsocontributed towards the same. Still we expect thecompany to maintain the growth momentum, as thedemand for sub 20 HP tractors is very strong.


Sales realization per Power tiller and Tractor


• The sales realization per Power tiller stood at Rs113,834 for FY 2011.

• Over the last 5 years, the realization per tiller hasincreased at the rate of 4% per annum.

• Since the sales of tillers is supported by the Govt.subsidy scheme, the prices are approved by all thestates once in a year and the company has to maintainthe price irrespective of the raw material priceincrease during the year.

• The sales realization per Tractor stood at Rs 221,309for FY 2011.

• Over the last 5 years, the realization per Tractor hasincreased at the rate of 4% per annum.

• It is relatively easier to pass on the raw material priceincrease in the case of tractors.

Margins – Pricing power & Economies of Scale

• The Gross margins of the company have hovered in therange of 32-35% over the last 5 years.

• We believe company has done well to maintain itsGross margins and has more or less been able toincrease the prices of its products in line with theincrease in prices of the raw materials.

• Farm equipments is a price sensitive sector, more so inthe case of Tillers as the same is driven by National andState Govt. subsidies. Being able to pass on price hikesreflects a strong pull for the company’s products.


• As can be observed from the above illustration, theoperating profit margins of the company haveimproved over the years.

• While it used to be 10-12% earlier, the increase inoperations over the years have helped the companyachieve economies of scale with Operating profitmargins now in the range of 15-18%.

• We believe that margins peaked out in FY 2010, andshall settle in the range of 15-16% over the longerterm.

Power Tillers - Overview

• In the segment of Power Tillers, VST commands a market share in excess of 45%. The sale of Power Tillers issupported by the Government subsidy scheme. For ex., in Karnataka the subsidy is 50,000 and in Orissa thesubsidy is 60,000 per tiller and incidentally Orissa has now become the largest consumer of power tillers withannual sales of 10,000 tillers inclusive of VSTs sales of 4,500 tillers. Orissa remains a high potential marketconsidering both the small land holdings and under penetration of farm mechanization in the state.

• For FY 11, VST sold a total of 23449 tillers while at present the company has a total capacity of 36,000 (tillers +tractors) at Bangalore plant. Once the new tractor plant comes up in Hosur, the entire Bangalore plant of thecompany will be available for Power Tillers. Thus, we don’t see any capacity constraints at least for the next 2-3years. Besides company has also started importing Chinese Tillers in order to get a share out of the market whichis preferring an economy model or a lower HP power tiller. However the share of sale from Chinese Tillers is stillminuscule, with VST importing only 562 Tillers during FY 2011 and 371 during FY 2010.


Tractors – Overview

• VST Tillers was primarily a Power Tillers manufacturing company, however off-late the Tractors segment of thecompany is gaining traction and is rather growing at a scorching pace of 30%+.

• Keeping small land holdings in perspective, VST has created a niche of its own in the tractors space bymanufacturing 18.5 HP tractors while all the major players are competing in the 25-55 HP segment. Its onlyrecently that Mahindra has launched a 15 HP Tractor after realizing the immense potential for small tractors.

• As per the management, the sub 20 HP tractors are extensively used in grape vineyards, cotton fields, sugarindustry etc. because of their unique features like compact size, 4 wheel drive, less weight and low cost. VST iswitnessing huge demand from its dealers and the demand waitlist is very strong for its 18.5 HP tractors. In order toaddress the same, the expansion plans have already been initiated and should commission by 3rd quarter of FY2013.


Production Capacity and Utilization

• As can be observed from the • The 36,000 productioncapacity accounts for the


• As can be observed from theillustration to the right, thecompany reached 94%capacity utilization at the endof FY 2011.

• Since then company hasincreased the combinedcapacity by another 20% atthe end of H1 FY 2012,considering the demandwaitlist for its tractors.

The 36,000 productioncapacity accounts for themanufacturing plant atBangalore.

• Another 25000-30000tractors manufacturing plantwill come up at Hosur bySep’12.

• The same should help thecompany maintain thegrowth rate for another 3years.

Country wide dealer network

A wide dealer NetworkReaching every Corner

Over the years, VST Tillers Tractors has established anextensive and efficient countrywide sales and after-sales network backed by easy availability of spareparts.

VST has very strong presence in the Southern,Western and North-Eastern states of India. The


Western and North-Eastern states of India. Thecompany is not trying for a pie of Northern states asthe land holdings in northern states are large & thusnot suitable for VST’s Power Tillers and < 20 HPTractors.

Till now, Tractors sales constituted less than 25% ofthe entire sales of the company, however with thecommissioning of new manufacturing plant fortractors in 2012, the strong and widespread dealernetwork shall help the company scale up the saleeasily.

Strong product pull

• For companies like VST, a strong dealer network serves the role of marketing agents, after sales service agentsand at the same time act as a strong moat against competition from new and marginal players. Also thedistribution network enables the company to launch and test market new products, considering they havealready build in good reputation amongst the farmers community.

• Though VST has in place a strong dealer network, the company is further strengthening it with every passing yearand the same is evident from the fast compounding dealer’s deposits. Also, the company witnessed a sharpincrease in advances from customers and dealers towards the end of FY 11.

• We believe there’s a strong pull for VSTs tractors and tillers and the same should help the company maintain 25%growth rate.


Consistently earning high return on shareholders funds

Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return. The worst business to own is one that must, or will, do

the opposite—that is, consistently employ ever-greater amounts of capital at very low rates of return. Unfortunately, the first type of business is very hard to find . . .”- Warren Buffett

• In case of VST, the capital includes shareholders equity as it’s a debt free company and VST has done justice toshareholder’s funds by consistently earning ROAE (Return on Average Equity) in excess of 20%.

• So whatever portion the company is retaining as a part of net profits, they are deploying the same at 20%+returns. At the end of FY 11, the company had close to 50 crore cash and cash equivalents earning low return forshareholders. Now that company has embarked on expansion, the return on equity and thus the growth mayfurther increase FY 13 onwards.


Earnings estimates for FY 15 (E)

• 30,000 tractors manufacturing facility at Hosur• 30,000 tractors manufacturing facility at Hosur• Earnings estimate for FY 2015 (E)


30,000 tractors manufacturing facility at Hosur

In many concalls and in variousdiscussions, management hasindicated that they are witnessingvery strong demand for their tractorsof 18.5 HP.

In order to capitalize on the same,VST is setting up a second factory atHosur with a production capacity of30,000 tractors (on double shift basis)per annum.per annum.

The capacity is expected to come uptowards the 2nd- 3rd quarter of FY2013.

At present the company is sellingclose to 5,000 tractors per annum, soonce the second factory is up andrunning, it could give a major boost tothe revenues of the company.


Earnings estimate for FY 2015 (E)

We have outlined some basic assumptions for estimating the FY 15


We have outlined some basic assumptions for estimating the FY 15turnover and net profit. We believe that the estimates areconservative and would rather be happy if the companyoutperforms our estimates by a large margin as the managementitself has set a target of 1000-1100 crore turnover by FY 2014.

We don’t expect equity dilution during the period as VST issufficiently funded, generates good cash flows and is debt free.

There’s a high probability of company registering much higher Tillersales than the 33,000 assumed, as the industry is growing at 15-18%, while in the tractors segment, achieving higher capacityutilization should be easy as the demand backlog is strong.

Management Quality

• Shareholding Pattern• Distributing 15%+ profits as dividends• Managements’ Remuneration


Shareholding pattern

• The Promoters of the company, VST Group, have been firmly holding 50.98% equity in the company since long,while Mitsubishi Heavy Industries Ltd. holds another 2.93% taking total Promoter holding to 53.91%.

• As can be observed from the above illustration, institutions, both FIIs and DIIs have been increasing their stakessteadily over the last few quarters.

• At 350-400 crore market cap, VST Tillers is a sizable company and is under the radar of institutional investors.

• Novastar International Funds holds 2.39% stake (from 1.44% in Dec’09) in the company and they have beenincreasing their stake with every passing quarter. In the past, they have made some great investments in stockslike Bajaj Electricals, TTK Prestige, Shriram Transport, etc. They invest in profitable publicly listed small capcompanies that have the potential to emerge as leaders.


Distributing 15%+ profits as dividends

• While VST has no defined Dividend Policy, however they have been consistently distributing 15%+ of their netprofits as dividends.

• A consistent and increasing dividend payout, in line with the profitability, is reflective of the wealth sharingattitude of the management.


Managements’ Remuneration

• We like the companies with the management that derive major portion of their remuneration from Performancelinked commissions. Also one should be cautious about companies where the management take home more than10% of net profits as remuneration.

• In the case of VST, it is good to see that over the last 5 years the annual fixed salary component hasn’tincreased much. Also, the total Management remuneration is just 1.70% of the net profit of the company.


Industry Overview

• Higher farm mechanization – Higher farm productivity• Higher farm mechanization – Higher farm productivity• NREGA: Farm mechanization, an unintended consequence• Tractors – Low penetration; high growth potential• < 20 HP Tractors – Very buoyant demand• Government subsidy driving tiller sales in India• Power tillers: Grossly underpenetrated, thereby huge potential


Higher farm mechanization – Higher farm productivity

There’s no denying thatavailability of adequate farmpower is very crucial for timelyfarm operations for increasingproduction and productivity.

The power productivityrelationship shows that thoseStates having higher farmpower availability/ha havehigher productivity.


higher productivity.

Considering the fact that FoodSecurity Bill has been passed, itcan be concluded that theadditional requirement of foodgrains in future will be metthrough improving productivityby using more farm equipments,more specifically theequipments like Tillers, Tractors,etc.

NREGA: Farm mechanization, an unintended consequence


Interference with price signals has been the bane of public policy in India. The latest example is the labour marketdistortions caused by wage guarantee schemes. Business Standard highlights the sharp increases in farm laborwages between Jan’07 and Apr’11. It is estimated that farm wages have risen by an average of 70% in the past fouryears due to the success of the NREGA which has been in operation in all Indian districts since 2007.

One happy consequence of scarce and costly manual labour has been the pace of farm mechanisation, asmanifested in increased use of tractors, combine harvesters, small tillers, de-weeders and small power-drivensprayers.

Tractors – Low penetration; high growth potentialPe

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<20 HP Tractors – Very buoyant demand


India has traditionally been a medium HP (31-40 HP) market, accounting for 46.8% of market in FY08. Off late adistinct trend is emerging in the Indian tractor market, the increase in market share of low HP tractors. Althoughlow HP tractors only have a negligible presence even now, the segment has more than doubled its market share inthe past three years.

A combination of factors like labor scarcity and rising wages, better affordability of small marginal farmers and salesplateauing in traditional markets like Punjab among others - has slowed demand for 31-40 HP tractors that accountfor 45 percent of all tractor sales, while pushing demand for less-powerful, more fuel efficient tractors.

Out of about 105 million farmers who own land in India, about 80 million are small and marginal farmers. For mostof these farmers, the medium 31-40 HP tractors are too expensive and too big for their farms, while Low HP tractorsare affordable, making them a viable option.

Government subsidy driving tiller sales in India In FY11, the Indian Power Tiller Market was about 53,000 Tillers out of which, VSTTL sold 23,450 units, KAMCO sold12,000 units and Chinese imports (10-12 importers) were 17,000 units.

The Chinese imports today constitute 1/3rd of the industry volumes. VSTTL wants to buy out KAMCO (a Kerala stategovt. PSU) but the Kerala Government is not in favor of privatization.

Government subsidies is the single largest factor driving Tiller sales in India. The magnitude of subsidy is statespecific. For instance Chattisgarh is providing Rs. 90,000/tiller subsidy, while Jharkhand & Bihar are providing Rs.65,000/tiller. Assam Govt. in its FY10 Budget stated that 20 power tillers will be provided to each assemblyconstituency at 75% discount. Therefore, annual Tiller demand from Assam should be 124 constituencies x 20 =2480 tillers. Central Government subsidy on Tillers is Rs. 45,000.


Power tillers: Grossly underpenetrated, thereby huge potential

For the remaining amount (net of subsidy), PSU Banks give credit at 5% interest to farmers for Tiller purchases. Thegovernment thrust to increase in agricultural lending also works in favor of the Indian Tiller market.

Due to the huge subsidy, tiller prices are regulated by the government to some extent and VSTTL needs governmentapproval before increasing prices. A 2-3% price hike per annum is usually permitted. Overall, VSTTL is a beneficiaryof the govt. intervention in the Tiller market.

Indian Tiller market is growing at a rate of 15-18% for the last 5 years. This is expected to accelerate to 20% CAGRover the next 5 years. Orissa has the largest tiller market in India. During FY11, 10,800 units or 20% of all tillers soldin India were sold in Orissa.

Compared to 6,00,000 tiller units sold in China, only 53,000 units are sold in Indian per annum, though total arableland in India is more than in China. Even Bangladesh has sales of close to 50,000 units p.a. This comparison showsthe incredible under penetration of the tillers in the Indian farm land and thereby a huge opportunity.


Financial Overview

• Annual Performance – Consistent Growth• Annual Performance – Consistent Growth• Quarterly Performance – Margins under pressure for FY 12• Cash Flows – Occasional delay in release of subsidy• Balance Sheet – Adequately funded


Annual Performance – Consistent growth

• The track record of thecompany is marked byboth consistency andoutstanding growth.

• During the last 5-6 years,the environment’s beenboth conducive andtough at different times,however VST did well toweather through toughweather through toughtimes.

• The margins for FY 10were pretty high as therewas a windfall of exciseduty release, however wenow expect the net profitmargins to settle in therange of 9-10%.


Quarterly Performance – Margins under pressure for FY 12

• For FY 12, two quarters have passed and the company has recorded a turnover of Rs 250 crore against Rs 200crore turnover for the similar period of FY 11. So, the sales growth has been very strong while the operatingmargins and the net profit margins are under pressure on account of unabated inflation across all the industries.

• The management expects the raw material prices to remain high and have indicated that their Operating profitmargins will settle at 15% for FY 12 against 16% for FY 11.

• For the half year ending Sep’11, the company sold 3,235 tractors against 2,119 for the similar period last year,thus registering 52.6% growth while the growth in Tillers unit is a bit muted with a sales of 12,760 units against11,153 for H1 FY 11.


Cash Flows – Occasional delay in release of subsidy

• VST has reported positive cashflows from operations for eachyear during the last 6 years.

• Its average cash flow post tax forthe last six years is Rs 21 croreagainst reported average net profitof Rs 25 crore. The difference is onaccount of delay in release ofsubsidies.


• The direct taxes paid speaksvolumes of the accountingpractices. In case of VST, we areglad to see an increasing taxpayout at almost 32-33% ofreported Profit before tax.

• VST made short term investmentsworth Rs 32 crore in FY 11. Thecompany will liquidate the samefor setting up Hosur plant as andwhen the requirement arises.

Balance Sheet – Adequately funded • VST has a very strong balance

sheet with zero debt and asmall but interest free source ofcapital in the form of depositsfrom dealers.

• Out of a net block of 53 crore,28 crore is in the form of freeland, which includes the landrecently bought for HosurPlant.

• Out of a total investment value• Out of a total investment valueof Rs 36.83 crore, Rs 32 crore isin liquid investments.

• Besides, company is alsoholding cash and cashequivalents worth Rs 20 crores.Considering the same, we don’texpect company to go for debtor equity financing for its 100crore expansion project atHosur.


Concerns


• Power Tillers, which is one of the major contributor in VSTs sales is driven by Govt. subsidy. Any changein Govt. policy can adversely affect the operations of the company.

• Lack of credit facilities for farmers can effect their ability to purchase high cost tractors and tillers.

• A lot of bigger players like Mahindra and Mahindra, TAFE, International Tractors are eyeing a pie of <20

Concerns

• A lot of bigger players like Mahindra and Mahindra, TAFE, International Tractors are eyeing a pie of <20HP Tractors market share.

• VST for long has been facing problems w.r.t. sourcing of components from the vendors. In the absenceof adequate sourcing from the vendors, the company may not be able to achieve the desired levels ofcapacity utilization at its new plant, thus registering lower growth than anticipated.


Conclusion


Price chart

• VST is in general a highly volatile stock and witnesses sharp swings in each direction.

• As can be observed from the above illustration, the stock’s been range bound for some time in the channel of400-550. We expect the stock to find support at current levels of Rs 400, however in case the market turnsextremely bearish, the stock can witness a fall to the levels of Rs 330-350 i.e. a downside of 15-20%.

• We would therefore suggest a portfolio allocation strategy with 2% allocation at Rs 400-410 and further 2-3%allocation at Rs 340-350.


Katalyst Wealth – Alpha Portfolio

For more information on VST Tillers Tractors Ltd, discuss with Ekansh Mittal

Mail Id : [email protected] Mobile: +91-9818866676

Katalyst Wealth Alpha Portfolio service is focused on helping individual investors/institutionsbeat market returns by a wide margin without taking large risks through in-depth research,analysis and follow up on the stock.


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VST Tillers Tractors ltd (NSE Code VSTTILLERS) - Katalyst Wealth Alpha Recommendation