Agriculture and Tractor

The tractor industry reported a strong 28. 3% growth in sales volumes during 2009-10, thereby ending the phase of cyclical correction that had pulled down tractor sales during the preceding two years (200709). Significantly, the revival of 2009-10 happened despite the drought-like conditions in many States during the kharif1 season dampening sentiments. The key factor enabling the demand growth of 2009-10 was strong rural liquidity, which in turn was sustained by several factors, including higher minimum support price (MSP) for crops; the greater ability of farmers to make cash purchases (including the usage of Kisan Credit Card which is increasingly being used to part-finance tractor purchases); enhanced employment opportunities (with rural employment schemes being implemented by the Government of India); an improved credit environment; and continuance of replacement demand.

These factors apart, non-agricultural use of tractors (for haulage in construction and infrastructure projects) continued to increase, benefiting tractor demand. Also, with infrastructure projects and rural employment schemes increasing employment opportunities, availability of labour for agricultural activities continued to decline, persuading even farmers with medium-sized land holdings to either rent or purchase tractors. On a regional basis, the performance of the eastern, northern and western parts of the country was robust during 2009-10 in terms of tractor demand, while that of the southern region was moderate. Strong growth in tractor volumes, albeit on a low base, was witnessed in the eastern States, including Bihar, Orissa and Jharkhand, which had a good paddy crop. Tractor volumes in the northern and western regions also reported strong growth during 2009-10, especially in the second half (H2) of the year, benefiting from a low base (H2, 2008-09) and a satisfactory Kharif crop in some States. The southern region reported moderate performance in terms of tractor demand (growth of 11. 9% in 2009-10), being impacted largely by the de-growth in Andhra Pradesh (AP)—a key southern market—where rainfall was irregular in 2009-10.

However, in Karnataka and Tamil Nadu, higher MSPs for rice along with some revival of interest of public sector banks (PSBs) in tractor financing led to strong tractor sales volumes. Historically, tractor demand has been fairly volatile, being influenced by cyclical trends, availability of finance, and crop patterns (monsoon). After four years of strong growth during 2003-07, the fiscal years 200708 and 2008-09 both reported a marginal decline in tractor sales volumes, largely reflecting cyclical corrections. In addition to the cyclical dips, during H2, 2008-09, the industry also had to cope with the 1 Kharif season in India is during the south-west monsoon (June-October) ICRA Rating Feature Tractor Industry: An ICRA Perspective liquidity crunch, which pushed up interest rates, even as financiers resorted to more stringent lending norms in the face of rising non-performing assets (NPAs). However, the situation improved during 200910 as credit availability improved on the strength of greater liquidity in the banking system. While tractor financing has traditionally been done by PSBs, of late, private banks and non-banking finance companies (NBFCs), despite their higher interest rates vis-a-vis the PSBs, have been able to increase their penetration of this market on the strength of faster loan processing and use of more liberal credit norms. Overall, with tractor demand is closely linked to agricultural output, growth in farm mechanisation and farmers’ remuneration, the long-term demand drivers for the industry remain robust. The currently low levels of tractor penetration in India, strong Governmental focus on the availability of finance for agriculture mechanization tools and on rural development, increase in the use of tractors for nonagricultural purposes, and the growing emphasis on tractor exports augur well for the industry.

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Chart 1: Annual Trends in Tractor Sales Volumes Chart 2: Monthly Trends in Tractor Sales Volumes Source: Industry, ICRA’s estimates Source: Industry, ICRA’s estimates The tractor industry reported a compounded annual growth rate (CAGR) of over 20% in volume terms during the period 2003-07. The long up-cycle in demand was supported by several factors, including excise duty exemptions on tractors (2004-05), thrust on rural development, improved availability of finances for tractor purchase, and low-interest rates. The growth also came on a low base, with the preceding three fiscal years (2000-03) having witnessed a prolonged phase of volume correction. The cyclical correction during 2000-03 had been aggravated by the build-up of channel inventory with the major players having pushed aggressively for larger sales.

In contrast to this phase of cyclical slowdown, the one that happened during 2007-09 was less severe, with volumes declining by around 3%, despite the intermittent tightening of the liquidity situation during H2, 2008-09. The demand slowdown during H2, 2008-09 also impacted the profitability of the original equipment manufacturers (OEMs), that is, the tractor manufacturers, because of the high price inventory they were carrying. However, the situation improved on the cost structure front in H1 2009-10 with the softening of commodity prices preparing the ground for the industry to earn higher profitability margins. The pickup in volumes also lowered the overhead expenses for the tractor manufacturers, boosting their profitability. While the OEMs did not lower the listed sales price of tractors, the benefit of lower steel prices was passed on to the end customers via discounts. This is an accepted practice in the industry; given that once prices are lowered it is difficult to raise them subsequently. However, during H2 2009-10, the tractor majors increased the prices with the reversal of commodity prices and the discounts have also come down. ICRA Rating Services Page 2 ICRA Rating Feature

Chart 3: Trends in Profitability Margins of Select Players Tractor Industry: An ICRA Perspective Source: Company releases, ICRA’s estimates; refers to Profit before Interest and Tax (PBIT) and volume in the tractor segment Capacity utilisation in the tractor industry had hit a low during 2002-03, following large capacity additions and a volume slump. After that, capacity utilisation improved steadily but remained moderate at around 50% during 2008-09. In 2009-10, the tractor volume growth has helped the OEMs improve their capacity utilization; however, there is still excess capacity in the industry. Thus, over the medium term, most tractor manufacturers would not need to make any significant capital investments in building capacities. As discussed, the domestic tractor industry has to cope with demand volatility on account of cyclical trends and the strong linkages it has with agricultural production and monsoon rains. Many of the industry players have thus diversified into related products, including generator engines and cranes, besides focusing more on exports, to gain some insulation against the volatility in domestic tractor demand.

As for tractor exports, while a major part of that currently goes to the USA, the OEMs are now exploring various other markets across Europe, Asia and Africa for future exports. Industry Trends by Region The biggest markets for the tractor industry include States like Uttar Pradesh (UP), Andhra Pradesh (AP), Madhya Pradesh (MP), Rajasthan, and Maharashtra, which together accounted for around 50% of the total tractor sales in India during 2009-10. The tractor industry witnessed a strong y-o-y growth of 28. 3% during 2009-10, with most of the States reporting positive growth during the year.

Chart 4: Trend in Tractor Sales across regions Chart 5: Trend in Tractor sales across States Source: Industry, ICRA’s estimates Source: Industry, ICRA’s estimates The northern region remains the largest tractor market in India with sales of around 1,67,000 units as of 2009-10. This region reported a growth rate of 35. 7% in volume sales in 2009-10 over the previous fiscal, with the key contributors including UP, Punjab, Haryana and Rajasthan. The northern region benefited from higher MSPs (for crops), limited availability of labour (forcing higher mechanisation), and increasing non-agricultural use of tractors. Additionally, increased infrastructure development activities (especially highways) led to an appreciation in land values and the use of tractors for non-agricultural purposes. In some cases, farmers also received compensation for the Government’s acquisition of select land patches (adjoining highways), which increased the availability of cash with them. Feedback from industry players ICRA Rating Services Page 3 ICRA Rating Feature Tractor Industry: An ICRA Perspective suggests cash purchases (including purchases using Kisan Credit Card) in some northern States increased to 35-40% of the total tractor volumes in 2009-10 from 10-15% in the past.

Tractor volumes in UP grew by 42. 7% during 2009-10, with H2, 2009-10 reporting particularly strong growth (around 51% y-o-y) mainly on the back of high sugarcane prices for the Kharif crop and improved irrigation facilities. In the case of Punjab, tractor volumes remained strong for the fifth straight year in 2009-10 (y-o-y growth of 42%). In Rajasthan however, growth in tractor volumes was relatively subdued in 2009-10 (around 24% y-o-y) as compared with the figure for the northern region as a whole. Tractor sales in Rajasthan were especially low in H2, 2009-10 versus H1, 2009-10, due to lower Kharif output on account of deficient rains and inadequate financing availability. In the eastern region, tractor volumes continued to report strong growth in 2009-10, albeit on a small base and went up by 53. 8% over 2008-09, being driven mainly by the higher MSPs announced for paddy. Within the region, however, many financiers remained reluctant to finance tractor purchases in some states like Bihar. Nevertheless, in Bihar, tractor volumes grew 66% over 2008-09 to around 29,000 units in 2009-10, thereby accounting for over 50% of the total sales in the eastern region. The Bihar market, where tractor penetration had been low historically, has shown sustained growth over the last few years and become one of the important markets for the tractor industry. Overall, in the eastern region, growth in tractor volumes is expected to moderate, going forward, as the benefit of a low base gets diluted gradually. The western region reported sales of around 92,000 tractor units during 2009-10—a growth rate of 35. 7% over the previous fiscal—benefiting particularly from the strong performance that Maharashtra, Gujarat and MP posted during H2, 2009-10 (55% y-o-y growth over H2, 2008-09). The factors contributing to the strong growth in the region during H2, 2009-10 included a benign base effect, higher crop prices (of sugarcane and cotton in Maharashtra, and of cereals and soybean in MP), and greater availability of retail finance. The performance of the southern region in terms of tractor sales was relatively modest during 2009-10, with the growth rate being around 11. 9% over the previous fiscal. While most states in the region reported healthy growth, AP, which is the largest tractor market in the south, de-grew by 10. 4% in 200910.

The AP market has been undergoing a volume correction since 2007-08, with the preceding four to five years have witnessed a large and sustained volume growth; this factor apart, the de-growth of 2009-10 was also aided by irregular monsoons. The other big market in the southern region, Karnataka, reported growth of 74% in tractor volumes in 2009-10 mainly on the strength of higher MSPs for rice; however, volume growth is expected to moderate in 2010-11 because of the base effect. In Tamil Nadu, tractor sales were flat during H1, 2009-10, but the performance improved in H2, 2009-10 mainly because of improved retail financing by the PSBs. Industry Trends by Tractor Horse Power (HP) The Indian tractor market has traditionally been a medium HP market, with 31-40 HP tractors accounting for around 47% of the total industry volumes. In 2008-09, the 31-40 HP category had reported sales of 157,602 tractor units, which was about the same as the previous year’s figure but lower than the 2006-07 statistic by 7%. In 2009-10 however, this category reported a strong revival, with the volume growing by 22%2 over 2008-09; the revival was led by UP, Karnataka and Madhya Pradesh. The other major segment in the

Indian tractor market is the 41-50 HP range, which accounts for around 23% of the total industry volumes. This segment grew by around 10% during 2009-10, thereby underperforming the growth in overall tractor volumes (around 19%) that year. The main reason for this underperformance was the low growth that the southern region, the biggest market for this segment, reported in 2009-10. 2 The HP wise y-o-y growth rates are based on 9M 2009-10 tractor volumes. Page 4 ICRA Rating Services ICRA Rating Feature Tractor Industry: An ICRA Perspective. The >51 HP segment of the Indian tractor market also underperformed the industry growth rate in 200910 mainly because of the de-growth in the exports which is a key demand area for these high HP tractors. Some Long-Term Demand Drivers for the Industry Low penetration of tractors in Indian agriculture: Indian agriculture is characterised by low farm mechanisation, fragmented land holdings, and high dependence on monsoon rains (in the absence of adequate irrigation facilities). Tractor penetration in India is low at around 13 tractors per 1,000 hectares as against the global average of 19 and the US average of 29.

While this does indicate the relative backwardness of Indian agriculture, it also points to the significant scope that exists for raising tractor penetration, which bodes well for tractor demand over the long term. Government support for the agricultural sector: Although agriculture contributes just around 20% to India’s GDP, it provides employment to a large rural population, which is why the sector remains a strong focus area for the Government. The tractor industry benefits significantly from the Governmental focus on agriculture, with measures such as nil excise duty on tractors (even the excise duty on tractor parts has been lowered from 16% to 8%) and inclusion of tractor financing under priority sector lending (by PSBs) serving as long-term demand drivers. Financing of tractor purchase is of great significance for the industry, it is a key demand facilitator. Export of tractors: Indian tractor manufacturers have been increasingly targeting the international markets over the last few years. The industry exported a total of around 37,900 tractors during 2009-10, with the USA, Africa, South America, and some Asian countries being the top destinations.

The industry leader, Mahindra and Mahindra (M&M), has acquired Yancheng Tractors, the fourth largest tractor manufacturer in China (in terms of FY2008 volumes), to improve its presence in the country. In the developed markets, Indian tractors have a relatively marginal presence, with sales being largely restricted to the hobby farming segment. Outlook Tractor sales are expected to remain healthy in fiscal 2010-11, given the good rabi crop this time around, the continuing firmness in the prices of agricultural products, and the healthy monsoons anticipated during the coming Kharif season. Moreover, improving farm mechanisation levels (with labour availability in rural areas declining), increasing non-agricultural use of tractors, higher credit disbursements for agriculture, and sharper Governmental focus on the farm sector (larger budgetary allocations) are also expected to encourage tractor sales. The industry’s profitability is however expected to remain moderate in the medium term, considering the high competitive intensity and low capacity utilisation levels, although larger players could benefit from scale economics. As for margins, while they have seen an improvement in 2009-10, they would remain vulnerable to adverse changes in commodity prices. While some states in the northern region have achieved high levels of tractor penetration and farm mechanisation, on an all-India basis, the penetration remains low, which along with the current shortage of farm labour and consequently rising labour costs, may be expected to lead to greater mechanisation and use of tractors.

The long-term prospects for the Indian tractor industry hinge on agricultural growth and Government support in areas such as financing availability, tax exemptions, and fiscal stimulus for rural development. Overall, ICRA expects the long-term growth rate for the Indian tractor industry to trend around the historical average of 6-8%, supported by increasing tractor penetration. ICRA Rating Services Page 5 ICRA Rating Feature Tractor Industry: An ICRA Perspective Annexure I: Structure of the Indian Tractor Industry has around 13 national players and a few regional players. The industry is dominated by Mahindra and Mahindra (M&M) with a market share of around 41. 1%, followed by Tractors and Farm Equipments TAFE, which holds around 22% of the market. The other major players include Escorts (12. 1%), L&T-John Deere (7. 8%), and International Tractors Limited (8. 9%). During the last few years, the industry has seen some consolidation with M&M acquiring Punjab Tractors (PTL) and TAFE acquiring Eicher Tractors.

Most of the tractors sold in India are in the 21-50 HP range, with the 31-40 HP category alone accounting for around 50% of this. The long-term prospects of the Indian tractor industry are highly dependent on Government policies for the agriculture sector. Historically, most tractor sales are done on credit even as over the last few years financial institutions, facing an increase in their non-performing assets (NPAs), have resorted to some tightening of credit norms. Also, during 2009-10, there has been a sharp increase in cash purchases, reflecting the rise in disposable incomes in the rural markets. Most of the tractor financing done by banks come under priority sector lending, a directed-lending mechanism of the Government of India. In terms of volume, India is one of the largest tractor markets in the world, besides China and the USA. The prospects of the domestic industry are highly linked to monsoon rains, which remain a key factor in determining agricultural production. Better irrigated States like Punjab and Haryana have a high tractor density (over 100 per 1,000 hectares), while States like Rajasthan, Gujarat, Himachal, Tamil Nadu, Maharashtra, Andhra, MP and West Bengal has low levels of tractor penetration—a pointer to the substantial growth potential that the latter set offers. On an all-India basis, tractor penetration remains low at around 13 per 1,000 hectares. Besides being used in farming, tractors find application in activities such as harvesting and irrigation, land reclamation, drawing water and powering agricultural implements. In addition, lately, the tractors are also being used for non-agricultural purposes including haulage in construction and infrastructure projects which has expanded the tractor market.

The Indian tractor market, thus, is expected to grow in future and remain one of the biggest tractor markets in the world. Chart 6: Trend in State wise market share Source: Industry, ICRA’s estimates Annexure 2: Region-wise Market Shares of Various Players The market shares of the top four players in the Indian tractor industry did not change much during 200910 in comparison with 2008-09. M&M remained the market leader with around 41. 1% market share, followed by TAFE with a market share of around 22%, Escorts with around 12. 1%, and International Tractors (ITL) with around 8. 9%. ICRA Rating Services Page 6 ICRA Rating Feature Tractor Industry: An ICRA Perspective.

Chart 7: Movement in Regional Market Shares of Select Players 2009-10 vs. 2008-09 (bps) Source: Industry, ICRA’s estimates M&M remains particularly strong in the southern region (50. 4% market share during 2009-10). However, L&T John Deere (LT-JD) was able to increase its market share in the region by around 250 bps in 2009-10, mainly at the expense of M&M (market share down by 140 bps) and Escorts (down by 140 bps). In the western region too, LT-JD performed well in 2009-10, increasing its market share by 190 bps, even as TAFE lost market share by around 90 bps there. In the northern region, where M&M has been traditionally weak, the company increased its market share by 140 bps during 2009-10, even as ITL and Escorts lost market shares by around 90 bps and 60 bps respectively, there. In the eastern region, M&M was able to raise its market share by around 140 bps in 2009-10 at the expense of Escorts and TAFE.

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