Lead acid battery makers had a nice ride for many quarters on the back of high demand and good profit margins. But the road ahead may be arduous as the odds are mounting against these firms.
The two market leaders Exide Industries Ltd and Amara Raja Batteries Ltd may see weaker demand in the replacement market. This is a rub-off of weak automobile sales, mainly four-wheelers, between fiscal years 2012 and 2015. After all, replacement market sales follow automobile sales with a two- to three-year lag.
A slowdown in the replacement market sales is worrisome as this segment brings in about two-thirds of the operating profit for battery makers.
Next, some analysts say that there could be saturation in market share gains too.
A report by Kotak Institutional Research says, “Organized players (primarily Amara Raja) have outperformed industry growth due to market share gain from smaller unorganized players over the past five years. Together, Amara Raja and Exide have almost 90% market share in the four-wheeler replacement segment and further market share gains in this segment are unlikely."
If at all, some growth is likely in two-wheeler replacement market sales. But then, the operating profit accretion from this segment is lower than that from four-wheelers.
Also, like most other commodities, lead prices too have risen by a significant 20-25% in the last six months. This will weigh on profit margins until the battery makers are able to pass on this cost increase to consumers.
Given that the replacement market growth rate is likely to be subdued, manufacturers may be cautious in increasing battery prices in the replacement market. Some brokerage firms have justifiably trimmed operating margin forecasts for both Exide and Amara Raja by about 50 basis points for FY18. Only better-than-expected sales in the next two quarters can offset the impact of rising lead prices. A basis point is one-hundredth of a percentage point.
All the above factors triggered some sell-off in both company stocks since November. That said, at current levels, Amara Raja shares trade at a richer valuation (about 23 times FY18 earnings estimate) than Exide’s, which trade at around 17 times. The former’s scorching pace of sales and earnings growth in the last decade saw its valuation race past its competitor and market leader.
However, from these levels any further rise in stock prices will be powered by a favourable turnaround in the factors detailed above, which are critical to battery makers.