After a strong June quarter, battery makers are set to clock higher volumes over the next two years. The Automotive Component Manufacturers Association of India has forecast a 17% compounded growth rate in replacement market sales until 2016.

Although it is good news for the auto components sector as a whole, battery companies would be bigger beneficiaries as more than half their revenue comes from the replacement market. In the three months ended June, market leaders Exide Industries Ltd and Amara Raja Batteries Ltd beat the Street’s expectations both on revenue and profit as an auto boom in the previous years triggered replacement demand for batteries.

Also, dealers say some deferred purchases of batteries in the past six months could spill over into the current year. Although auto batteries are typically replaced after a couple of years, improvement in quality has stretched the life of a battery and, therefore, the replacement cycle. Further, according to Karvy Stock Broking Ltd, “Lower utilization of commercial vehicle fleet due to economic slowdown and cash crunch made customers defer replacement of batteries." The industry estimates that about a third of the vehicles on the roads currently are about 10 years old. This segment would tap the replacement market for auto components.

Higher demand will mean larger sales volumes during 2015 and 2016. Another positive development is that the last couple of years have also seen customers migrate away from the unorganized sector to companies like Amara Raja and Exide.

As volumes rise in the replacement segment, pricing edge will help raise operating margins. Further, analysts say economic recovery will also boost sales of industrial batteries, and those of UPS (uninterrupted power supply) devices and home inverters, giving both firms the advantage of operating leverage.

What could tell on margins, though, is a sudden spurt in lead prices or a volatile currency, which impacts imported lead costs. Raw material costs comprise about two-thirds of sales. Also, heightened competition in the replacement market may warrant higher advertising and marketing spending, which could reduce profitability.

For now, both stocks are fairly priced, trading at about 15-17 times 2015-16 estimated earnings per share. Consistent revenue accretion with adequate share of replacement market will sustain these stocks.

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