Right sales mix to help battery makers’ operating margins

Right sales mix to help battery makers’ operating margins

Adversity often forces firms to develop strategies to prevent profit erosion. In the last two quarters, battery makers, including Exide Industries Ltd and Amara Raja Batteries Ltd, had to combat the rising cost of lead, its main raw material, which accounts for nearly three-fourths of the cost of making a battery. They also faced sluggish demand in telecom and auto sectors. Both firms, which together comprise nearly 90% of the battery market, are trying to address these factors to manage profitability, which has been inching down in the last four-six quarters.

For the June quarter, Exide’s operating margin was down nearly 500 basis points (bps) from a year-ago period and that of Amara Raja, a smaller player, fell by about 100 bps. One basis point is one-hundredth of a percentage point.

No doubt the outlook for auto sales growth is sombre and is expected to be in single digit for fiscal 2012, from a heady 25-30% in the last two years. But battery makers are now adding capacity in anticipation of the huge and more remunerative replacement market potential in automobiles. Batteries are replaced in about two years and strong auto sales in 2009 and 2010 should, therefore, offer a good market for battery makers.

In an analysts’ conference call, the Exide management said it will enhance spending on advertising and promotion in the forthcoming quarters to energize dealers and attract customers. Capacity was constrained in the last few quarters, forcing it to cannibalize the more remunerative replacement market sales to satisfy the burgeoning original equipment (OE) segment. Brokerages say an improvement in the ratio of replacement-to-OE sales will swing margins as the former is nearly three times more profitable.

Meanwhile Amara Raja, which is doubling capacity in two-wheeler batteries, plans to carve out about one-fifth share in the large two-wheeler OE segment, even as it is trying to gain market share in the replacement segment. But analysts are sceptical about its capacity in telecom batteries, given that the domestic telecom segment is sluggish. Perhaps that is why its valuations are at a 45% discount to that of Exide. The firm is, therefore, tapping telecom markets overseas through innovative steps such as the accord with Bharti Airtel Ltd to enter African markets.

Fortunately, there has been a respite in lead prices, which have cooled off since April. In fact, in the June quarter, profit was hit as raw material costs as a percentage of sales rose by more than 300 bps from a year ago. But benefits of lower lead prices will trickle in from the second half of the current fiscal.

Both Exide and Amara Raja are trying to improve revenue momentum, as the operating leverage along with the fall in lead prices could help sustain profitability. However, although both shares have outperformed the BSE Midcap and auto indices since January, they look fairly valued. Exide trades at nearly 19 times and Amara Raja about nine times fiscal 2013 earnings.

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