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India Battery Sector
Charged up for growth
We estimate India’s battery sector would post a 17% CAGR over FY10-13E driven by 18% CAGR in auto segment sales
and 15% CAGR in industrial segment sales over the same period.
We expect strong auto sector demand – from both the OEM and the replacement segments – to result in 18% CAGR in
auto battery sales over FY10-13E.
Industrial battery sales, too, are likely to grow strongly driven by the demand outlook for UPS and railway/power
application batteries.
Given the duopoly in the industry, we do not expect price wars to break out any time soon. The resultant pricing power
and cushion against input prices deserve a premium valuation, especially for the vertically integrated player (Exide).
We initiate coverage on Exide with an OUTPERFORM rating and price target of Rs201 and on Amara Raja with IN-LINE
and price target of Rs172.
Investment summary
Battery industry to grow at 17% CAGR – We expect strong demand from both the auto OEM
and replacement segments to result in an 18% CAGR in automobile battery sales over FY10-
13E. We believe the slowdown in telecom-sector battery demand is likely to be offset by robust
demand for UPS batteries and for railway/power application batteries. We estimate overall
industrial battery sales to post a 15% CAGR over FY10-13E. Overall, we expect the battery
industry to post a strong 17% CAGR over FY10-13E.
Duopoly imparts pricing power, industry to continue to trade at a premium to peers –
Given the duopoly in the industry (the top two players command over 80% organized market
share), we do not expect any price wars in the immediate future. Moreover, given the top players’
pricing power, we expect them to be able to manage the volatility in lead prices without affecting
earnings. Led by relatively stable cash flows and high return ratios, the battery industry will
continue to trade at a premium to its peers, in our view.
Exide is our top pick – We expect Exide’s premium valuation over Amara Raja to rise given
Exide’s backward integration benefits and small exposure to the telecom sector, which results in
superior earnings growth (26% over FY10-13E) and robust return parameters. We initiate
coverage on Exide with an OUTPERFORM rating and SOTP-based 12-month price target of
Rs201. With no positive triggers for Amara Raja and slower earnings growth of 11% over FY10-
13 (earnings remain highly sensitive to lead prices; exposure to telecom may hinder potential
upside) and trading at 8.3x FY12E earnings, we believe the stock is fairly valued. Initiate with INLINE
and price target of Rs172.
Risks – Lead price fluctuations and battery imports are the key risks.
Investment argument and valuation
We believe strong demand from the domestic automobile sector (17% CAGR over FY10-
13E) and sustained offtake from the replacement segment is likely to drive an 18% CAGR
in auto battery sales over the same period. Moreover, we expect the lull in telecom battery
demand to be offset by strong demand for UPS batteries and railway & power application
batteries. We don’t expect any price wars either, given the duopolistic nature of the
industry. Given the above, battery manufacturers trade at a premium to industry peers.
Auto sector growth to drive battery sales
We expect the domestic battery industry to maintain strong sales growth. We expect growth to be
driven by 1) the robust outlook for the auto OEM segment (auto battery sales from this segment
likely to grow at a 20% CAGR over FY10-13E) and 2) rising demand from the replacement
category as more customers shift from the unorganised to the organised market (we factor in a
16% CAGR over FY10-13E). Overall, we expect auto battery sales to post an 18% CAGR over
FY10-13.
Industrial battery sales likely to grow at 15% CAGR
Computerisation of banking networks and government departments, creation of high-powered
data centres in IT and financial services industries, increasing penetration of PCs and continued
power shortages are likely to drive demand for UPS/inverters. We expect the UPS/inverter
battery segment to grow at an 18% CAGR over FY10-13.
Furthermore, modernisation and expansion of the Indian Railways over the next five years are
likely to drive battery sales for railway applications. We expect railway battery sales to post a
15% CAGR over FY10-13.
We expect these two sectors to offset the slowdown in telecom battery demand – we expect it to
grow at a 5% CAGR over FY10-13. Thus, we estimate overall industrial battery sales to post a
15% CAGR over FY10-13.
Duopoly imparts pricing power
Given that the top two battery manufacturers command ~80% market share, we believe they
have significant pricing power. In addition, given that batteries are critical components of any
application, we believe that an established brand is a key criterion in any customer’s purchase
decision. This also gives top players pricing power. Given the above, we believe a price war is
unlikely in the industry. This is one of the main reasons why the industry has reported relatively
stable cash flows over the years despite sharp volatility in lead prices.
Valuation
Led by sustained demand for batteries and price escalation clauses protecting their earnings
from raw material volatility, the battery industry has traditionally experienced very high return
ratios. This is especially true for vertically integrated players like Exide, which results in further
insulation against input prices and the key reason for its superior earnings growth and return
parameters vs. Amara Raja.
In addition, leading auto ancillary suppliers (including Bharat Forge, Bosch, Motherson Sumi and
Exide) with substantial pricing power enjoy relatively stable margins, high return ratios and hence
trade at a relative premium to their industry peers.
Exide: Premium valuations justified
We value Exide’s core business at Rs179 (at 18x FY12E earnings; 20% premium to its average
one-year forward multiple of 15x) and its stake in ING at Rs14 and subsidiaries at Rs8, to arrive
at our price target of Rs201. We believe the stock warrants a premium (over its historic multiple)
given backward integration initiatives (captive sourcing to increase to 70% by FY13E).
This will not only lead to margin expansion going forward (our estimates factor in 100bps margin
expansion over FY10-13E) but also improve the quality of earnings, which in our view will
deserve premium valuations vs. historical average. At our price target, the stock would trade at
20x consolidated earnings and P/B of 4x, which given its return ratios (RoCE of 36%, RoE of
27%) and higher quality of earnings, is justified. Within the domestic battery industry, Exide has
always traded at a 50% premium to Amara Raja given scale, leadership and distribution network.
Amara Raja: Fairly valued
Amara Raja’s revenue growth is likely to remain robust, but its earnings are highly sensitive to
lead prices given the lack of backward integration. In addition, significant exposure to telecom
may limit upside potential given slowdown in the sector. Nevertheless, with return ratios in excess
of 20%, we believe the stock deserves to trade at least at its average multiple of 8x (which is also
a 55% discount to Exide’s target multiple). We initiate coverage on Amara Raja with an IN-LINE
rating and price target of Rs172. While the imputed P/B of 2x at the target price appears
reasonable vs. RoE of 23%, we believe that the stock will not get re-rated easily given the high
volatility of earnings to lead prices.
Risks
Raw material cost volatility may impact earnings
Lead prices, around 80% of total cost, has been very volatile off late. Volatility in lead prices
remains a key risk to our estimates. Volatile crude oil prices in the international market also affect
the price of PPCP, used to manufacture battery containers.
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.
Rising threats from imports
Imports from China and some ASEAN countries are a threat to existing players primarily because
of product pricing. This price differential, though, has come down significantly owing to the
cancellation of VAT export refund in China for all lead battery manufacturers.
Auto demand to drive battery sales
We expect strong demand from both the auto OEM and replacement segments to result in
an 18% CAGR in automobile battery sales over FY10-13E.
Strong OEM auto sales
We expect the domestic auto sector sales to post a 17% CAGR over FY10-13 given strong GDP
growth and rising disposable incomes. This, in turn, is likely to drive OEM battery demand.
Furthermore, the strong growth witnessed by the automobile industry over the past five years
(11% CAGR over FY05-10) should lead to high replacement demand for batteries. In addition,
rising disposable incomes is likely to lead to customers shifting to the organised battery segment
from the unorganised. Furthermore, as consumers move up the value chain, usage of battery
driven applications (power windows, indicators, music systems, etc) would increase substantially,
leading to reduced average battery life, in our view.
Promising outlook for industrial batteries
We believe the slowdown in telecom battery demand is likely to be offset by robust
demand for UPS batteries and for railway/power application batteries. We estimate overall
industrial battery sales to post a 15.4% CAGR over FY10-13.
The industrial battery market is largely influenced by demand from the UPS, railway, power and
telecom segments. In the telecom sector, the batteries support switching and transmission
networks, whereas the Indian Railways use batteries for train lighting, coach air conditioning and
signalling. In the power sector, the batteries support generation, transmission and distribution
networks. The UPS batteries support IT and ITeS operations; they form part of UPS systems,
which provide backup power and regulate power supply to critical equipment during voltage
fluctuations. Small VRLA batteries find application in small UPS and emergency lamps.
We highlight below a few factors that will continue to drive demand in the industrial battery
segment.
Addition of high-powered data centres in telecom, IT, BFIS and government sectors,
continued growth in ATMs at 18% CAGR and massive government-funded projects such as
Accelerated Power Development and Reform Program (APDRP), National e-Governance Plan.
According to Gartner, India's IT end-user spending is likely to grow at a 14.8% CAGR (2007-
12), generating US$110bn in business in 2012; e-Governance is a US$9bn business
opportunity.
To address the continued demand-supply gap in power, the government has revised the
incremental power capacity target from 78,577MW to 92,700MW during the 11th Plan (2007-
12) with the objective of raising per capita consumption to 1,000kWh by 2012.
The large-scale computerisation of banking networks and government departments, creation
of high-powered data centres in IT and financial services industry, increasing penetration of
PCs and power shortages are likely to drive a sustained demand for UPS/inverters. We
expect the UPS/inverter battery segment in the country to grow at a 18% CAGR over FY10-13.
Further, the robust modernisation and expansion plans of the Indian railways are likely to drive
battery demand for railway applications, going forward. We expect the railways-led battery
demand to grow at a 15% CAGR over FY10-13. We expect battery demand from telecom
operations to grow at a slower 5% CAGR over FY10-13E. Therefore UPS, railways and power
sectors are likely to offset the slowdown in the telecom space.
Thus, we expect overall industrial demand for batteries to post a 15% CAGR over FY10-13.
Duopoly imparts pricing power
Given the duopoly in the industry (the top two players command over 80% organized
market share), we do not expect the industry to see any price wars in the immediate future.
Top two players command above 80% market share
The Indian battery industry is a duopoly with Exide and Amara Raja controlling ~80% of the
organised market. Exide is the market leader in the automotive segment, commanding over 70%
market share. Amara Raja enjoys leadership in the industrial segment with 35% market share in
the telecom segment. Amco, which is a marginal player in the overall market, commands a
healthy 15% of the two-wheeler battery market.
Volatile lead prices
Lead prices have become extremely volatile of late. In FY08, lead prices touched a low of
US$1,945/tonne and a high of US$3,980/tonne. In FY09, the low was US$880/tonne and the high
US$2,955/tonne. In FY10, the high-low was US$2300/US$1,500/tonne. To protect themselves
from such volatile lead prices, most battery manufacturers have a lead price escalation clause
agreement with OEMs wherein they are able to pass on the increase in raw material price, albeit
with a lag of a quarter
Given that a battery is a critical component in any product, quality plays a key role in the
purchase decision of a customer. Both Amara Raja and Exide have tie-ups with established
international players and have established brands over the past several years. Thus, this industry
has high entry barriers. Given the duopoly (the top two players command 80% of the organized
market), we do not expect the industry to witness any price wars in the immediate future.
Thus, while margins may decline over a high base in a rising raw material cost scenario, this
clause helps protect earnings in the long run.
Battery industry:
Automotive segment comprises 64%, industrial comprises the rest 36%
The Rs90bn Indian battery industry comprises two major segments, automotive batteries that
account for ~64% and industrial batteries that account for 36%. The automotive battery segment
could be divided into OEM and replacement segments. The industrial battery segment comprises
railway & power sector, UPS/inverter and telecom sector.
Automotive battery segment
Auto OEMs contribute about 30-35% of sales while the balance is driven by replacement
batteries. OEM sales, despite being a low-margin business, provides for high visibility and brand
building for the players. This segment has grown at 15.2% CAGR over FY08-10 driven by 14%
demand CAGR of the automobiles.
Replacement demand provides a stable business by diversifying risk when OEM demand slows
down. Stability is inherent to the industry given the replacement segment accounts for 60-65% of
total auto sales and contributes 15-18% to operating margin. Typically, the life of a battery is
about three years and has to be replaced after that. Buoyant growth in automobile demand has
percolated to the replacement segment, which has grown at a CAGR of 15% over FY08-10.
Industrial battery segment
Industrial batteries are classified into conventional (lead acid), valve-regulated lead acid (VRLA)
and nickel-cadmium batteries. The VRLA batteries have been gaining increasing acceptance and
currently comprise ~75% of the Indian industrial storage battery market. Industrial battery sales,
mainly driven by VRLA batteries, logged ~18.8% CAGR over FY08-10. Industrial and
infrastructure growth is a major driver of this segment. The 11th plan expenditure for railways is
estimated at Rs2trn, which will eventually percolate down to the industry. Further, the sustained
demand supply mismatch of power in India has driven a 15% CAGR in UPS demand over the
last five years. Telecom towers, which use batteries for power supply, contributes 35% to the
segment.
Industry cost structure: highly raw material intensive
Lead is the key raw material used in storage batteries accounting for around 80% of total RM
cost. Typically, any increase in raw material prices is passed on by the players in the
replacement market. In case of OEMs, players have ‘lead escalator pricing contracts’ i.e., rise in
cost of production due to increase in lead prices is borne by the OEM. Thus, volatile lead prices
in the recent past have marginally impacted industry margins as realization has increased
consistently.
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