Amara Raja Batteries: Buy

Strong replacement demand for automobile batteries and improved telecom and UPS battery sales power the growth prospects of Amara Raja Batteries Ltd (ARBL). Investors with a one-to-two year perspective can buy the stock.

The company derives about 60 per cent of its revenues from the auto segment, where it counts Ford, Maruti, Hyundai, Honda, Mahindra & Mahindra, Tata Motors and Tafe, among its clients. The industrial division, which primarily makes telecom and UPS batteries, brings in the rest of the revenues.

At the current market price of Rs 248, the stock trades at a price-to-earnings ratio of about 13.4 times its estimated earnings for 2013-14. With its bigger peer, Exide Industries, facing loss of margins and market share until a few months ago, the valuation gap between ARBL and Exide has narrowed. Still, it is at a discount to Exide, which trades at 15.8 times its estimated FY-14 earnings.

Replacement drive

From about 11 per cent (year-on-year) growth in the year ended March 2012, overall volume growth in the auto industry deteriorated to about 2.6 per cent in 2012-13 and worsened to a 2.1 per cent fall in volumes in the April-June 2013 period.

During such a slowdown in new vehicle sales, battery manufacturers remain better off among auto component makers, as there is a huge market for replacing old batteries in existing vehicles. For instance, even as new vehicle volume growth in 2012-13 was nothing to write home about, ARBL witnessed a volume growth of 20 per cent in four-wheeler battery sales, primarily driven by replacement demand.

In the next few months, with new vehicle sales hardly set to look up, demand will continue to come from replacement markets. Batteries are typically changed every three-four years.

The scorching pace of growth in auto sales in both 2009-10 and 2010-11 implies that the battery replacement demand for vehicles sold at that time will support the company’s growth prospects now. Seventy per cent of ARBL’s auto segment revenues come from the four-wheeler replacement market. Two-wheeler battery replacements also bring in a marginal contribution to revenues.

In contrast to direct supplies to manufacturers, where there is not much bargaining power, higher sales in the replacement segment endows the ability to pass on cost escalations easily. The company has hiked prices in the replacement market in December 2012 and in March 2013.

ARBL is expanding capacities for four-wheeler batteries. Capacity expansion for two-wheelers is also going on. While tie-ups with two-wheeler makers for direct supplies could be margin-dilutive in the short-run, these relationships would help expand the replacement market for these batteries later on.

Towering high

Prospects for the telecom and UPS segments too, are equally good. A slowdown in network expansion plans and sharing of tower infrastructure by telecom operators had kept the demand for telecom batteries down in the last two years. But this is changing as replacement demand for batteries supplied earlier is beginning to drive growth. Secondly, a rise in bulk diesel prices is also moving telecom customers from gensets to batteries.

ARBL supplies the higher margin ‘Quick recharge’ range to Indus Towers whose customers include Airtel, Vodafone, Idea, Aircel and Reliance Communications. It expects demand for these batteries to drive growth in this segment. Besides, the increasing trend of data transfer using larger bandwidth and 3G/4G availability will strengthen demand for telecom batteries in the near future as it requires upgrading existing networks.

UPS batteries have also seen an uptick in sales in the last couple of quarters, so much so that demand has outstripped supply. New capacity for UPS batteries is coming on stream by December 2013. E-governance projects initiated by the government, creation of high-powered data centres and modernisation of existing ones, deeper penetration of personal computing devices and continued power shortage situation are expected to keep the market for UPS batteries going.

Financials

For the quarter ended March 2013, ARBL’s net sales grew 19 per cent year-on-year to Rs 801 crore. A higher proportion of traded goods increased expenses, curtailing profit growth. Net profit grew only about 2 per cent to Rs 59.6 crore. Capacity expansion is expected to bring down the share of traded goods in the next two-three quarters.

Operating margin stood almost flat at 13.9 per cent. However, margins may be impacted negatively in the first half of FY14.

Although international prices of lead, a key input, have cooled off from $2,400 per tonne levels in January to around $2,000 levels currently, the depreciation of the rupee is expected to offset the benefit.

Given the robust demand, ARBL may be able to mitigate this impact to an extent by passing on the costs to customers in the replacement segment.

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