Market valuations of two leading battery makers—Exide Industries Ltd (EIL) and Amara Raja Batteries Ltd (ARBL)—have come off 25% from their historic averages. An anticipated slowdown in key end-user segments such as automotive and core manufacturing made investors turn cautious on the demand outlook for batteries.
At the current market price of Rs115, EIL stock trades at around 12 times the estimated one-year forward earnings compared with its historical average of 16 times, while the ARBL stock, at Rs196 apiece, trades at nine times compared with its average of 12.
Falling values apart, both EIL and ARBL rest on strong foundations: good management and almost zero debt, with the latter being significant given the current high-interest rate scenario. Besides, the key driver for earnings growth—the replacement battery market—will see an increase from the first quarter of fiscal 2013 (vehicles added on road post-2010 will have to replace batteries that have a life of around three years).
In fact, the scorching growth rate of 25% plus every year, over the last two years, across the auto segment will lead to higher battery replacement rates in future. This segment, which enjoys better margins than OE (original equipment) segment, comprises close to half the battery makers’ revenue.
Any improvement in replacement volumes will, therefore, improve profit margins too. In fact, this is well corroborated by the 14.1-percentage points drop in EIL’s operating profit margin during the September quarter from a year ago. The management attributed this to cannibalizing of volumes by OE segment from the replacement market forced by capacity constraints.
Further, the sluggish telecom segment, which also affected volumes, revenue and profits for both EIL and ARBL in the last two quarters, is now stable. ARBL management says that battery customers are now willing to recognize quality and pay realistic prices, and volumes are gradually inching up.
Further, the demand from the growing services sector is likely to support industrial inverter demand.
But EIL’s exposure to home inverters, where demand is lacklustre, may contain volumes. ARBL, which does not cater to home inverters, is better off; its September quarter performance exceeded market expectations. Its net profit was 65% higher from a year ago, while that of EIL fell by 76% because of low utilization and capacity constraints.
This explains the divergence in stock performance of the two firms. ARBL stock has outperformed market leader EIL, benchmark BSE-500 and BSE Auto indices. The outperformance is backed by divergent expectations for fiscal 2012; while ARBL’s earnings are likely to grow 15-20% in fiscal 2012, capacity constraints and the resultant poor performance, so far, may culminate in an earnings contraction for EIL. However, going ahead, higher product volumes and utilization of capacity will drive revenue and profit momentum for both companies.
The price of lead (the key raw material in making batteries) has dropped 16%, which will also ease pressure on margins. The only catch here is rupee depreciation, which, to some extent, negates the impact of falling prices. The sector has the trigger points that investors seek, such as beaten down valuations and an improving outlook; and unless some new risks crop up, it appears to have the potential to deliver on these expectations in the medium- to long-term.
Graphic by Yogesh Kumar/Mint
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