If there is one industry that will be mightily pleased with the Budget 2004-05, it is the tractor industry. The industry one of the worst performing sectors till lately, is all set for revival thanks to the budgetary measures announced by the Finance Minister. The FM has been generous enough to exempt the industry from excise duty altogether, from the earlier rate of 16 per cent. Basic customs duty, however, stands at 20 per cent. Moreover, parts consumed in the factories of manufacturers have also been exempted from excise duty.
But if you think this will translate into a proportional fall in tractor costs or that the benefit will be passed on fully to customers, think again. This is because from now on, since the company will not be paying any excise duties, it will also not be able to gain modvat benefits on raw materials consumed. It, therefore, cannot set off the duties paid on raw materials consumed as it did earlier. Thus, the actual gain for the manufacturers might be lower than anticipated.
Other Benefits Too...
Nevertheless, there are several other indirect benefits for the sector accruing from the Budget 2004-05. The government’s intentions of doubling agricultural credit in the next three years, impetus to irrigation, water-harvesting schemes, crop-risk mitigating measures too are likely to spur offtake of tractors.
This is not all. Customs duty reduction on steel from 15 per cent to 10 per cent, will also marginally lower the cost of production for tractor manufacturers. These moves bode well for tractor manufacturers such as M&M, Eicher Motors & Punjab Tractors.
First, a boost in agricultural incomes is the main demand driver for tractors and, in fact, there is a very strong correlation between tractor sales and agricultural growth in the country.
Secondly, reduction in duties will no doubt lower costs to an extent.
After three particularly forgettable years, exacerbated by poor monsoons, there has been some respite for the industry in FY04. The signs of revival are clearly visible from the fact that the industry was able to sell an aggregate of 1,91,600 units in 2003-04, up from 1,72,500 units last year.
The lean period also prompted some corrective action that will reflect favourably in the long run on the bottomlines of these companies.
One such measure has been the discontinuation of ‘advance delivery’ that was impeding the cash flows of these companies and hurting the manufacturers by inducing undue business risk.
Long-term Story
The penetration level for tractors in India at 11 tractors per 1,000 hectares of gross cropped area (GCA) is lower than the world average of 19 tractors per GCA hinting at the potential in the longer run.
Moreover, exports, according to CRIS INFAC, should account for nearly 10 per cent of the industry’s volumes in 2003-04 and there is scope for improvement, especially in the lower horsepower segment (21-40 HP) since tractor exports have risen 30 per cent CAGR between FY 1998-2003. Also, going forward, tractor industry should benefit from - ‘multiple applications’ which means they will be used more for commercial purposes other than purely agricultural. Also, with changing customer profile, correlation of the tractor industry with the macro economy will increase insulating it from cyclicality in agriculture.
Conclusion
However, there is a small caveat — of rising input costs —- that will have a telling effect on the margins of tractor manufacturers. Costs of key inputs like steel, pig iron have gone up by as much as 15 per cent lately and are unlikely to subside keeping margins under pressure in the near future.
Moreover, competition has gotten a bit more intense what with a couple of players announcing a price cut recently. This will put the rest of the players under pressure. Yet there is no denying the fact that the industry is headed in only one direction: north.
However, it must be borne in mind that the extent of benefit on stock prices of individual companies will accrue to them on their relative market and fundamental strengths.
