Amara Raja: Hold

Shareholders can retain their investments in Amara Raja Batteries (ARBL), a player in the industrial and automotive storage batteries business. At the current market price of Rs 159 (post-split), the stock trades at a P-E of 14 times the trailing 12 months earnings. This is a discount to Exide Industries, the market leader. The potential for high growth in the telecom and UPS battery segments and higher replacement demand for automotive batteries due to the buoyant automobile sales in the last few years are positives for the company. But firm trends in the prices of lead, the key raw material, and competition from bigger players such as Exide remain a concern. The stock has appreciated considerably in the past one year giving over 80 per cent returns. Investors with a long-term view, however, can consider exposure on weaknesses relating to the broader markets.

Under the brands ‘Power Stack’ and ‘Quanta’ in the industrial segment, the company manufactures batteries for the telecom, railways and the IT and ITES industry.

It provides automotive batteries branded ‘Amaron’ to Ashok Leyland, Mahindra and Mahindra, Tata Motors, Maruti and Hyundai, among others. Both segments contribute equally to revenues.

Prospects

As telecom service providers expand their networks and get into sharing infrastructure, the company will benefit from the increased demand for batteries, which support their tower and exchange infrastructure. UPS battery sales will be propelled by growth in the IT and ITES industry, which requires back-up power, and the demand from households and offices due to the continued power shortage situation.

In the automotive segment, the existence of a de-risked sales mix catering to passenger cars, tractors and commercial vehicles will help the company tide over a slowdown better. Besides, the rollout of new models by the OEMs may bring the opportunity to become sole suppliers for that model ensuring a steady revenue stream. Fuelled by the rising demand, the company had embarked on capacity expansion last year. Besides, it is also setting up a greenfield plant with a capacity to manufacture one million units of two-wheeler batteries by Q3 FY-08 and five million by FY-09.

In a bid to boost volumes and improve their market share in the higher margin replacement market, the company has conceptualised retail outlets called ‘Power Zones’ to be set up in rural and semi-urban areas. A network of 500 stores is to be set up in FY-08.

Concerns

Raw material costs account for about two-thirds of sales and lead constitutes 70 per cent of the raw material used. India is a net importer of the metal; international lead prices have seen a huge rise since the beginning of this year. Operating margins have declined from around 18 per cent to 15.6 per cent in the latest quarter, mainly due to raw material costs which have shown over a 100 per cent increase for the same period. Part of this rise was offset by passing it on to the customers.

Although the battery-makers increased prices earlier this year, the company may face resistance to future price increases as automakers themselves are faced with a slowdown and OEMs are looking at cost-cutting.

Exide has announced plans to increase prices by a further 7.5 per cent this month, but Amara Raja is yet to follow suit. Exide has also announced plans to buy out a smelter to recycle used lead-acid batteries which will help them reduce input costs.

While the capacity expansion for industrial batteries was completed in FY-07, the automotive and two-wheeler battery divisions are expected to start contributing to revenues by FY-09. Until then, net margins could be impacted by way of higher interest and depreciation costs. Given the slowdown in the two-wheeler segment, there are uncertainties surrounding the contributions from the company’s foray into the making of two-wheeler batteries.