Lead is a critical input used to make batteries. Exide Industries Ltd’s September quarter results showed how critical, as a surge in lead prices meant that even a significant growth in sales contributed to a meagre growth in net profit.
To be sure, a recovery in sales of UPS (uninterrupted power supply) systems and higher sales of automotive batteries both in the replacement and original equipment segments powered a 23% year-on-year growth in net revenue to Rs2,371.2 crore. That was better than the average of 16 analyst estimates compiled by Bloomberg. Perhaps, a part of Exide’s growth was also due to restocking the pipeline in the new goods and services tax (GST) regime.
But that’s where the good news ended. At Rs295.9 crore, the company’s operating profit fell short of forecasts and was barely 2.3% higher than a year ago. The 25% jump in lead prices from the month of May was rather sudden. One wonders if Exide was able to pass on the higher raw material costs, which account for two-thirds of sales, totally to the end-user during the quarter.
Operating margin plunged by 2.5 percentage points from a year ago to 12.5% and was down by about three percentage points from the June quarter. The company’s tight cost management in other areas like employee costs and marketing expenses was commendable, and arrested a further decline in profitability.
The sharp drop in operating margin was worse than investor expectation, pegged at 14.5-15% for the quarter. While the company’s profits disappointed, one wonders if the stock will react negatively in the next few trading sessions, given there are factors in its favour as well.
Firstly, there is GST itself which, in the long term, will give Exide an edge over competition from the unorganized segment in the replacement market. Secondly, revenue growth is on firmer ground now than it was about a year ago, given economic recovery and a strong sales forecast for the auto sector in the coming quarters.
Lastly, Exide is proactively exploring new technologies that are cost effective. A note by HDFC Securities Ltd following the results announcement says that although falling lithium-ion battery costs along with traction in electric vehicles is a concern for lead-acid batteries made by manufacturers such as Exide, the company is trying to mitigate the risk by foraying into design and production of these batteries in collaboration with Chaowei Group of China.
For the present, the real challenge will come from overcoming the inflationary effect of rising lead prices, and this pressure on margins may last for some quarters.
Meanwhile, in the September quarter, a Rs42 crore one-time expense towards settlement of a dispute dragged Exide’s net profit down. Even after adjusting for this, net profit fell by 2.3% over a year ago.
While strong revenue growth is indeed good news for investors, the stock price may not reflect that growth, unless lead prices ease off or realizations improve enough to offset higher costs.