Amara Raja Batteries: BUY

The Amara Raja Batteries stock has run up quite sharply in the last one year, gaining about 60 per cent. At a time when the auto industry has been going through a rough patch, some factors have contributed to the company’s good run.

For one, replacement market demand for batteries has been good. Secondly, after a lull, the demand for telecom batteries has improved in the last one to two years.

Amara Raja cashed in on the capacity constraints faced by its competitor Exide that led to market share losses and low profitability for the latter.

At the current market price, Amara Raja trades at around 15.6 times its estimated earnings for 2014-15, higher than the average of 12 times for the last five years. But Amara Raja’s outperformance over Exide has also led to the re-rating of the former and a narrowing of the valuation gap between the two stocks in recent times.

Amara Raja’s current valuation is still lower than Exide, which trades at 19 times its estimated earnings for 2014-15. This leaves room for comfort. Investors with a two-to-three year perspective can buy the stock.

Amara Raja derives about 60 per cent of its revenue from the auto segment, where it counts Ford, Maruti, Hyundai, Honda, Mahindra & Mahindra, Tata Motors and Tafe among its clients.

After a scorching 26 per cent growth in 2009-10 and 2010-11, the auto industry slowed down in the last three years, with only around 3 per cent volume growth in 2013-14.

Amidst 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. Higher sales in the replacement segment also bring better margins as there is more pricing power here.

With an average replacement cycle of three-four years, the demand for replacing batteries for vehicles sold in 2009-11 has kept volumes ticking for Amara Raja so far.

For the nine months ended December 2013, Amara Raja witnessed a growth of 32 per cent in replacement market sale of two-wheeler batteries and a 16 per cent growth in four-wheeler batteries. The company has a market share (replacement market) of about 25 per cent and 37 per cent respectively in these two segments. In the months to come, replacement demand for cars and commercial vehicles is expected to cool off somewhat, considering the prolonged slowdown. At the same time, the anticipated recovery in the economy after the elections should boost new vehicle sales and battery demand.

The demand for two-wheeler battery replacements though could hold on, as two-wheelers have been among the better performing segments during these slowdown years.

Besides, there should be an increase in direct sales to two-wheeler manufacturers, a segment in which the company plans to build a greater presence in the coming years.

These relationships will help expand the replacement market for these batteries later on as well.

Amara Raja has currently tied up with Hero MotoCorp, Honda, Bajaj Auto, and Mahindra and Mahindra for direct supplies.

Capacity expansions funded predominantly by internal accruals are ongoing for both the two-wheeler and four-wheeler segments.

There is a risk that higher direct sales to auto manufacturers could slightly dilute its current margins of 16-17 per cent. But this could be mitigated to a certain extent through better product mix in the industrial batteries division.

The prospects for telecom and UPS batteries also look good. A slowdown in network expansion plans and sharing of tower infrastructure by telecom operators had kept the demand for telecom batteries down until early 2013.

But this is changing as replacement demand for batteries supplied earlier is driving growth currently.

Besides, telecom companies are replacing their diesel generators with batteries. The company expects demand for the higher margin ‘Quick Recharge’ batteries to drive growth in this segment. Also, the increasing trend of data transfer requires upgrading existing networks.

The company is striving for a 55 per cent market share in this space by 2014-15 from 48 per cent now.

Amara Raja has only a marginal presence in the home inverter battery segment which is facing difficulties currently due to the improved power situation. It is instead focused on UPS batteries for industries.

E-governance projects, expected increase in banking and ATM networks, and demand from IT and ITES industries are expected to keep the market for UPS batteries going.

For the nine months ended December 2013, Amara Raja’s net sales grew by 18 per cent over the corresponding previous period to ₹2,551 crore.

Adjusted net profit grew by 22 per cent to ₹ 287 crore. Operating margin stood at 17.1 per cent, from 16.5 per cent the previous year. There is a risk of profitability being impacted due to an escalation in the price of lead, the key raw material. International lead prices have remained weak in recent times, hovering around $2000 per tonne.

A moderate supply deficit forecast for 2014 might firm up prices a bit from these levels. Amara Raja’s pricing power should help pass on the cost rise.