Higher lead prices to weigh on Amara Raja, Exide

After gaining 20 per cent after its September quarter results, the Amara Raja stock corrected by three per cent in trade on Thursday. The gain had followed the results last week, which saw a strong 380 basis point (bps) improvement in the operating profit margin to 16.7 per cent, compared to the June quarter's five-year low of 12.9 per cent.

The change was on account of price hikes across segments, an improved product mix, with high share of replacement market sales, and increase in margins for the home UPS battery business. However, this is where good news ends. Analysts expect the road ahead to be bumpy, especially for margins, beside competitive pressure in certain consumer segments. The relatively higher valuations also suggest that further gains for Amara Raja’s stock could be restricted vis-à-vis Exide.

Margins

While Amara Raja saw sequential improvement in margins in the September quarter (Q2), Exide’s fell 290 bps to 12.5 per cent over the June quarter, due to higher lead costs. Margins for both companies were down in the 50-250 bps range on a year-on-year basis.

Margins are expected to be under pressure for both companies, as lead prices have increased further by 14 per cent from the June quarter. This will make it difficult for companies to raise prices further, given the competitive pressure. While Exide's management did not give any forecast, Amara Raja said 14-16 per cent operating profit margins were sustainable and the company would stay at the upper end of the band. Analysts at Kotak Institutional Equities, however, say that rising lead prices and weak demand in the industrial segment will remain major headwinds.

Given the growth and margin scenario, analysts have cut their earnings per share estimates for both companies by three to five per cent. Bank of America Merrill Lynch analysts also believe that lead prices are likely to weigh on margins. Further, a weaker product mix, limited pricing flexibility in the replacement segment, given increased capacities, and higher competition from Exide will add to Amara’s margin pressures, they add.

Revenue

Exide reported a 23 per cent increase in revenues in the September quarter; for Amara Raja, growth was limited to seven per cent. While automobile and UPS systems have done well for Exide, Amara Raja continues to face headwinds in its key segment of telecom (a fifth of revenue). Pressure in the telecom segment is expected to impact Amara Raja’s revenue in the coming quarters as well. The company gets half its industrial revenue from telecom and this is under pressure with the sharp rise in competitive intensity there after the entry of Reliance Jio. Segment revenue, estimate analysts, fell about 20 per cent year-on-year.

Further, a higher focus of Exide in the segment has made matters worse. In addition to pricing pressure, Amara Raja has not participated in some loss-making orders, leading to revenue fall. Its market share in the telecom segment is down from over 60 per cent earlier to 50 per cent currently. Given the trend in telecom, Amara Raja is likely to be more impacted — telecom is a fifth of its revenue but less than three per cent for Exide.

 
The other industrial segments of industrial UPS and railways are doing better. Amara Raja expects 13-15 per cent growth in revenue over the medium term, on the back of strong demand in the automotive segment and market share gains from the unorganised space. For Exide, Edelweiss’ analysts estimate revenue to grow about 14 per cent annually during FY17-19.

What should help both expand their market share across categories (two and four-wheelers) in the replacement market is the shift from unorganised to organised segment, with implementation of the goods and services tax (GST). Aggressive expansion by Amara and Exide, coupled with GST tailwinds, should help bring down the unorganised share by a significant margin.

In the electric vehicle market, while there will be no immediate impact, both companies are raising their presence through own technology or tie-ups, offering solutions in both the traditional lead acid or the newer lithium ion segments.

Valuation

Despite the visible underperformance in the past year, Amara Raja is trading at 23 times its FY19 estimate, while larger peer Exide trades at a discount to Amara at 19 times.

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