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Amara Raja Batteries: Fairly valued, initiate with IN-LINE
Equity Research report by Standard Chartered Research India
We initiate coverage on Amara Raja with an IN-LINE
rating and price target of Rs172.
Significant exposure to declining telecom demand and
rising lead prices are likely to slow earnings growth to 11%
over FY10-13E.
At our price target of Rs172, Amara Raja would trade at 8x
FY12E earnings, in line with its 4-yr average one-year
forward multiple of 8x. Looks fairly valued.
Significant exposure to declining telecom demand – Given
the slowdown in the telecom industry, pricing pressure on
telecom batteries (28% of Amara Raja’s revenue) could impact
earnings, in our view. We estimate the 930bps yoy fall in margin
in 1H FY11 to 14.2% is partly due to the telecom slowdown.
Impacted by rising lead prices – The lack of backward
integration exposes Amara Raja’s earnings to lead price
volatility. Over the past five quarters, higher lead prices have
been one key reason for Amara Raja’s margin decline.
Expect slower 11% earnings CAGR over FY10-13 – Given its
exposure to slowing telecom demand and lack of backward
integration, we estimate Amara Raja’s earnings would grow at a
much slower 11% CAGR over FY10-13E (FY07-10 CAGR 35%)
despite 22% revenue CAGR.
Capex plans to shift product mix favourably – The Rs1.6bn
capex earmarked over FY11-13E will shift Amara Raja’s
product mix in favour of the high-demand auto sector.
Valuation: Price target of Rs172 – At 8.3x FY12E earnings,
the stock is trading at its 4-yr average one-year forward multiple
(which is in line with its historic 50% discount to Exide) and
appears fairly valued. Initiate coverage with an IN-LINE rating
and price target of Rs172.
Investment argument & valuation
We initiate coverage on Amara Raja with an IN-LINE rating and price target of Rs172.
Significant exposure to declining telecom demand and rising lead prices are likely to slow
earnings growth to 11% over FY10-13E. At 8.3x FY12E earnings, it is trading at its average
one-year forward multiple and looks fairly valued.
Significant exposure to declining telecom demand
Almost 28% of Amara Raja’s earnings come from the telecom segment, where it is a preferred
supplier to all major telecom infrastructure and service providers and enjoys 35% market share.
Amara Raja introduced the VRLA technology in India for telecom applications and today it has
the largest installation base of VRLA products.
Vendors to the telecom sector have been impacted over the past few quarters because: 1) most
telecom players have substantially pruned their capex plans and 2) significant competitive
pressure has dented vendor margins.
The slowdown in the telecom sector and rising lead prices led to a sharp 930bps yoy decline in
Amara Raja’s margin in 1H FY11 to 14.2%.
We estimate battery demand from telecom to post 5% CAGR over FY10-13E. This coupled with
wafer-thin margins in the segment is likely to impact Amara Raja’s margins going forward.
Impacted by rising lead prices
Despite price escalation clauses, Amara Raja’s earnings have been exposed to lead price
fluctuations. It is also exposed to exchange rate movements, which magnify the impact of input
cost pressures. To add to its woes, margins in the telecom space have significantly shrunk in the
recent past due to decreasing capex and heightened competition.
The lack of backward integration exposes Amara Raja’s earnings to volatile lead price
movements. We expect margins in FY11 to be impacted by rising lead prices and slowdown in
telecoms (in 1H FY11 margin has contracted 930bps to 14.2%). Going forward, we expect
margins to remain at these levels, which is near its historic average of 14.6%.
Capex plans to shift product mix favorably
Amara Raja plans to expand its auto battery capacities for which it has earmarked Rs1.6bn –
doubling two-wheeler battery capacity to 3.6m in FY11 and to 5m by FY12; raising four-wheeler
capacity 20% to 6m by FY12. The capex is likely to be funded by internal accruals (see details
below).
Amara Raja also plans to cap exposure to the low-margin OEM segment to about 25% of its
revenues. Post this capex plan, the product mix is likely to shift 60:40 in favour of the auto
segment, thereby reducing its dependence on the slow-moving telecom segment.
Expect slower 11% earnings CAGR over FY10-13
With an established brand and a pan-India presence, Amara Raja is likely to benefit from the
strong outlook for India’s battery market. We estimate Amara Raja to post 22% revenue CAGR
over FY10-13E. Nevertheless, high exposure to telecom and lack of backward integration could
result in margins stabilising at lower levels of about 14.6%. We thus expect Amara Raja to post a
much slower 11% earnings CAGR over FY10-13E.
Valuation
At 8x FY12E earnings, the stock is trading at its 4-yr average one-year forward multiple (which is
in line with its historic 50% discount to Exide) and appears fairly valued. Initiate coverage with an
IN-LINE rating and price target of Rs172. With return ratios in excess of 20%, we believe the
stock deserves to trade at least at its historic multiple of 8x.
Risks
Input cost pressures
Increasing lead prices in the international markets continue to be a cause of concern for the
Indian battery industry. Volatile crude oil prices in the international market also affect the price of
PPCP, which is used for manufacturing battery containers. Increases in crude oil prices also
increase transportation costs for raw materials and finished goods.
Rising threats from imports
Relatively inexpensive imports from China and some ASEAN countries have been a key concern
for the indusrty. Thailand, in particular, is seeking to expand the scope of its free trade agreement
with India to include batteries. While Chinese batteries have been flooding certain Indian markets
for quite some time, the price differential has come down over the last few years.
Telecom sector slowdown
Most of the telecom majors have substantially reduced their capex over the next few years. Also,
led by heightened competitive pressures, telecom OEMs are squeezing margins of their ancillary
suppliers including that of battery manufacturers. A sustained slowdown in the telecom space is
likely to impact earnings for Amara Raja going forward.
Large unorganized market may restrict potential upside
The unorganized market (estimated at around Rs20-25bn) gives tough competition to the
organized players, especially in rural areas where the latter has limited reach. The growing
unorganised market poses a serious threat to the organised battery segment in India.
Financials
22% revenue CAGR expected over FY10-13
Volume growth in the auto battery segment/replacement category and strong potential in the
UPS/railways could offset the decline in telecom, in our view. Furthermore, its capex plans would
tilt the product mix towards autos and, hence, reduce Amara Raja’s overall exposure to telecom.
We estimate its revenue to post a 22% CAGR over FY10-13.
Earnings to grow at a slower 11% CAGR over FY10-13E
The robust revenue growth (22% CAGR over FY10-13E) is expected to be mellowed by margins
stabilising at lower levels resulting in a much lower earnings CAGR of 11% over FY10-13E. We
expect net profit margins for the company to stabilise at 8% levels over FY12-13E.
Company profile
Over the past decade, Amara Raja, in a JV with Johnson Controls (each holding 26% in the
company), has grown to become the second largest battery manufacturer in India. It has an
installed capacity of 4.8m four-wheeler batteries, 1.8m for two wheelers, 1.8m for UPS batteries
and 900m Ampere hrs of industrial batteries. Amara Raja markets these products under the
brand name of Amaron with variants.
Amara Raja is a preferred supplier to most of the four-wheeler players including Ford, General
Motors, Maruti, Hyundai and Daimler Chrysler for diverse platforms with a ~20% market share.
Even in the organized replacement segment the company enjoys a ~28% market share.
The company is a preferred supplier to all major telecom infrastructure and service providers and
is one of the largest battery suppliers to utilities. Under the brand Amaron, the variants for the
industrial space are Power Stack (large VRLA) and Quanta (medium VRLA). Amara Raja
ventured into small VRLA batteries in 4Q FY10.
Within the railways segment, Amara Raja powers over 50% of Tier-II and III AC coaches and
over 40% of their signalling and telecom power supply.
The company has an integrated automotive battery manufacturing facility at Tirupati. The
company has a strong distribution network of 200 wholesale franchisees and 18,000 retailers and
750 rural retailers (Power zone).
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