Amararaja Batteries Limited: Powering Ahead


(Dhwanil Desai) #1

Hi,

I am still not very sure that this stock is not covered in any of the discussions previously. However, since I was not able to find any thread on this company, I thought it appropriate to put my thoughts here.

Let me begin with a disclosure as per latest guidelines by valuepickr admin team.

Disclosure: I do have position in ARBL which was taken @ 300

Commpany Profile: Amara Raja Batteries Limited (ARBL) is one of the largest battery manufacturing company in India. It has two divisions namely automotive and industrial. ARBL has very popular brands like Amaron, Powerzone and Quantas and very wide distribution network of 274 franchises across the country.ARBL is promoted by Mr.Ramchandra Galla. Jhonsons Control, world’s largest automotive battery manufacturer, holds 26% in the company. ARBL has grown from strength to strength over the years and has successfully challenged the monopoly position of Exide in India. ARBL was the first company to introduce advance technology VRLA in India giving exide run for the money in Industrial segment and capturing growing telecom tower market.

Business Environment:

ARBL caters to two main segments namely automotive batteries and industrial batteries. In India, branded battery segment is duopoly with Exide and ARBL dominating the market. Even though Exide garners larger share in automotive market due to its relationship with two-wheeler and four wheeler OEM, ARBL is fast catching up. Over the years, vehicle owners are slowly shiftingfocus from unbranded battery to “proven and branded” automotive batteries which is helping both Exide and ARBL. Considering the duopoly nature of the business and perecieved value of the “brand”, there is moderate pricing power. Typically, companies are able to increase prices with some lag to raw material (mainly lead which constitutes 60% RM cost) price.

Automotive segment

Exide is present in all the segments of automotive batteries namely four wheeler OEM, four wheeler after market, two wheeler OEM and two wheeler after market. ARBL is present in all except two wheeler OEM which it is trying toget foothold innext 2 years. ARBL commands 26% in four wheeler OEM, 34% in four wheeler after market and 24% in two wheeler after market. It has marquee client list like Maruti, Honda, Hyundai, GM, Mahindra, Tata, Chrysler, Swaraj, Ashok Leyland and many other names

Industrial Segment

ARBL has developed a fairly robust product portfolio catering to needs of various industry including telecom, power, railways, oil & gas and UPS. ARBL introduced VRLA technology in industrial battery segment by leveraging its colloboration with Jhonsons Control. This move changed the competitve landscape by making a big dent in Exide’s monopoly. This early advantage was carefully scaled upby ARBL.As a result,now ARBL has become market leader in telecom and UPS sector with 46% and 32% market share. To give some more perspective: Over 50% of Indian railway’s two and three tiered AC coaches are powered by ARBL batteries

to summarize on the business side

)- battery manufacturing is relatively simple business (for sure no rocket science!)

)- It is a steady and scalable business. every 3-4 years these batteries needs to be replaced and so the demand for the product is definitely going to go up only as they sell more batteries

-Operates in duopoly with moderate pricing power and competitive environment is benign

)- Has strong brands such as Amaron, Powerzone and Quantas with well established distribution network across the country. In my opinion business that combines brand, reach and pricing power is very likely to qualify as high quality business.

Financials and Fundamentals:

I am not posting numbers here as 10 year financials are available on its website itself.

http://www.amararaja.co.in/annual_reports.asp

If we look at 10 year history, following can be inferred.

Profit & Loss:

)- ARBL has grown its topline and bottom line have grown at CAGR 30% and 40% respectively even though from a lower base in 2001-02. In last 5 years ARBL has grown CAGR 18% on both topline and bottom line.Even though topline has grown consistently in all 10 years, bottom line degrew in two years 2003-04 and 2010-11.

Balance Sheet:

-Very good management of balance sheet inspite of very high growth rates. Current debt to equity stands at 0.1 while the highest debt to equity was 0.95 in 2007-08. It has also managed its working capital needs well as its net current assets/sales dropped from 0.43 to 0.22. ARBL holds roughly 300 crores as cash on its balance sheet which is deployed in bank FD and liquid funds.

Cashflow:

ARBL has been generating positive operating cash flow for last few years and is typically slightly more than its net profit. Moreover, if we take into account depreciation as maintenance capex, company has been generating substantial free cash flow. ARBL is paying small part of this FCF as dividends whilethe larger partis redeployed in business for growth. I have no quarrels with this as management is generating very decent return on the capital and as Mr.buffet puts it the best business to invest in is the one where large amount of incremental capital can be deployed at high rate of return.

Ratios:

As warren buffet puts it, any business in the long term can not grow its value at higher rate thanreturn it generates on its equity (ROE)and hence it is the single most critical parameter. ARBL has fairly decent trackrecord on this front. It has improved its ROE from 4.5% in 2001-02 to 29% in 2011-12. Moreover, Since 2006-07, ARBL has consistently generated ROE in excess of 20%. Similarly, ARBL has been able to expand its net profit margin from 4.6% to 9.1%. Both these indicates improving quality of business.

Management Quality:

As I went through ARBL’s annual reports, I was impressed. ARs are exhaustive and gives a good sense of where business is going with clear articulation of future course of action. Moreover accounting is standard and I was not able to find major objectionable points. Management is doing a great job in terms of disclosures. Moreover, Jhonsons Controls 26% equity gives me lot of comforton corporate governance front. In general, my sense is that ARBL management is competent and transparent with no major negatives.

**Valuations: **

ARBL is currently trading at TTM P/E of 12.5 which is fairly decent considering impressive historical growth rate, ROE of more than 25%, free cash flow generation and simple, steady and scalable business run by reasonably good quality management. Management has given guidance of 15-20% growth in bottom line which if we take on its face value, we are talking about forward P/E of 12.In terms of margin of safety, on a very rudimentary basis, if I assume 10% FCF growth rate for 10 years, 3% terminal growth rate and 12% discount rate, typical margin of safety is around 20%. However 10% growth rate is conservative considering past track record, size of the opportunity and growth plans. I do feel it is a high quality business and hence intrinsic value is going to grow considerably due to inherent quality of business.

Risks:

Significant rise in lead price is one of the key risk as it directly impacts ARBL’s margin. ARBL’s competitor (Exide)has its captive lead smelter capacity which typically helps Exide reduce its lead cost. Thus Exide will be able to absorb rise in lead price more effectively with lesser “pass through” to end user. It will be difficult for ARBL to increase price in absence of price increase from Exide in after market segment and hence its marging may ger impacted in that pertucular segment.

Another threat I see is when Exide starts cutting its margin to improve its market share or stop eroding its market share. Even though, it is a distant possibility, it can not be ruled out.

In all, I think ARBL isa high quality business which is simple, steady and scalable, run by decent managementand available at a decent valuation.

I invite views of fellow boarders on the same.


(Hitesh Patel) #2

I had studied it earlier and looks like a fantastic company worthy of place in a long term investment portfolio.

great write up on this one from you.


(Saurabh Srivastava) #3

The only issue here is the intent shown by Jaydev Galla to fight the next elections for Congress.


(Dhwanil Desai) #4

Hi Hitesh,

Thanks for your compliments on write up.

Yes, for me it is pretty high conviction stock due to the quality of business. I did a small scuttlebut before making a investment decision. Ihad to replace battery in myactiva and I did a small survey in the market with mechanics andbattery shops, asking them a simple questions “which battery should I buy?” To my astonishment, almost 90% said without hesitation “amaron”. I probed them further saying that I have not heard about this battery, how about Exide? Many of them replied that Amaron is even better than Exide in terms of quality and slightly cheaper too! This indeedgave good filip to my conviction level. These people deal with batteries day in and day out so I do think their opinion reflects the value proposition offered by company’s products and its brand power. So yes, I doagree that itdoesdeserve place in long term portfolio.However, I think purely from value perspective, I typically buy stock only if margin of safety is in excess of 30%-35% as it gives me some room to make errors. I have heard a lot on this forum about what an excellent stock picker you are…I would love to hear your views on how much one should be willing to pay for a quality business?

I will appreciate your views.

Best Regards

Dhwanil Desai


(Dhwanil Desai) #5

Hi Saurabh,

Yes, I also read the news but I am not too worried at this point as I would not like to make an assumption that just because promoter is wanting to enter politics, it is bad for the business. I think the business economics is very good and till now management’s trackrecord has been spotless. Moreover, I see 26% stake by Jhonson’s control as big comfort on corporate governance side, especially with two nominee directors on the board. So in nutshell, unless Mr. Galla actuallyenters politics and does something awfully bad, I will bet on the business.

Best Regards

Dhwanil Desai


(Hitesh Patel) #6

dhwanil,

before the q1 results were out the appropriate price to pay was somewhere close to 300 and below.

But with the strong performance shown in first quarter, it looks like a sort of re rating is underway. Now onwards I think 350 should be a floor.

It seems to be scoring over exide both in terms of market share as well as margins and has an excellent balance sheet plus access to technology of Johnson Controls.

In battery markets it is a virtual oligopoly out there and hence I feel based on ttm earnings stock could comfortably go up to 450 levels.

For growth stocks which are either no 1 or no 2 in a oligolopy market like batteries, and especially in a market where growth is scarce, the appetite for stocks like amar raja might only increase as we go forward.


(Dhwanil Desai) #7

Hi Hitesh,

Thanks for your views. I too tend to agree that generally,quality companies are not available “cheap” and one has to be ready to pay ‘reasonable’ price which in hindsight will look cheap. However another aspect that is kind of playing on my mind is that apparently there are no negatives which I am able to think of. Typically, I look at a company with an eye of ‘skeptic’ to understand what are the negatives that market is able to decipher and hence pricing stock so as to make it look attractive. I am not able to get anything on that front even after repeating my skeptical analysis excercise twice. It would be great if fellow boarders can chip in with questions/queries/skeptical view to further analyze it from that angle.

Best Regards

Dhwanil Desai


(sandeep) #8

Hi Dhwanil,

I just got to know from someone that the Lead prices are technically looking strong and there is a high chance of going higher which might impact its margins to some extent in the coming quarters. Also there is a chance of rally in commodities in the short term if FED / ECB acts …


(Dhwanil Desai) #9

Hi Sandeep,

Frankly speaking I do not know much about commodity market technicals (or for that matter even in equity markets). However from investment perspective, I feel it is too early to assume that margins will be lower as lead prices are likely to go up. Typically ARBL and Exide both pass on increase in lead prices. So even if lead prices increase, I would wait and watch how much of that increase is passed on to the end user and how well ARBL maintains its margin. To give you an example, I have 10 years of lead price data from LME exchange, lead prices have increased from 450 to 2000 i.e. CAGR 16%. During the same period, ARBL has not only maintained its PBDIT margin but slightly improved it from 14.6% to 15.1%. On the net margin front, as i mentioned before, they have improved margins from 4.6% to 9.1%. So, they do seem to possess pricing power in the longer term even though for a quarter or two margins may get impacted.

Best Regards

Dhwanil Desai


(Ayush Mittal) #10

Hi Dhwanil,

Amararaja has been again and again making new inroads and capturing market share. This time (over last 1 year or so), the co has beaten Exide by a wide margin on financial performance also. This could be aninfectionpoint in getting the due recognition and the re-rating.

The only short term negative could be the severe slow down in automobile sector and hence performance below expectation of market after Q1. If so, it will be a good chance for long term investors like us to accumulate :slight_smile:


(Jigar Punamiya) #11

Dear all,

While comparing Exide & Amara Raja, I do not understand why do they trade at high difference in PE? Any particular reasons for it, which I am not aware of. Any special moat which Exide possesses, other than being a market leader?

-Jigar


(Hitesh Patel) #12

I think one has to put in some value for exide’s stake in insurance venture.


(Dhwanil Desai) #13

aninfectionpoint :))

Hi Ayush,

I completely agree with you that ARBL is nearing its inflexion point and due for re-rating. My view is that severe slowdown in battery demand from OEM may be compensated by replacement demand kicking in for the boom that existed in automobile market in 2008-09 onwards (as typical battery life is of 3-4 yrs). Management has also mentioned that as one of the growth avenues. Another prospective growth area is two wheeler OEM market which company is trying to tap. However, I too would be glad to see ARBL having one-two bad quarters for the price to soften for loading up! On the other side, if ARBL is able to give reasonably good performance for next 2 quarters, ithas high likelihood ofgetting re-rated.


(hemant gupta) #14

hi dhwanil,

the forex losses and slowdown in a particular segment is something that can happen again and tells me that the areas in which arbl is operating have fairly good sensitivity to overall economic activity. now that exide and arbl are going neck-to-neck in terms of market share, there is an increasing chance of a price-war here over the next few quarters if not over the longer term. arbl’s progress in acquiring market share in the OEM segment is a key monitorable for future course of growth. what kind of returns would you expect from arbl over the next 3-4 years if one term now?


(Ninad) #15

Hi Dhwanil

Let me at outset put a disclaimer that I have been holding the stock for the last couple of years and it is delivered great returns.

Having said that there are couple of variables to look at

  1. The current run up that has happened post the Q1 results is by virtue of a higher operating margin. Lower lead prices have clearly help the cause though I m not so sure whether it is sustainable and the company will revert back to 14-15% operating margin range.

  2. As mentioned by Ayush the impending slowdown in auto numbers especially in the two wheeler segment will act as a challenge on volume growth though you correctly mentioned that the replacement market should help negate some of it.

  3. Amara Raja also got lucky in the 2009-2011 phase because of a strategic misstep by Exide. In the market meltdown post the sub prime crisis Exide puts its capex on hold. Hence the sudden reversal in the business environment gave Amara the opporunity to expand marketshare because of capacity constraints at Exide. Having done that we need to understand how much of this marketshare gain is sustainable or will Exide fight to regain marketshare. A small example on this is the aggressive advertising that Exide has done with Salman Khan for SF Sonic. SF Sonic is Exide’s price warrior brand to take on Amaron while it maintains premium pricing for the Exide brand.

Having mentioned the above points the question that arises is whether Amara Raja has been lucky over the last few years bcos of a variety of reasons or that we have a superior management which will constantly gain marketshare from Exide.

Having said the above points I continue to hold and will add in case I get it at lower levels.

Cheers

Ninad


(Dhwanil Desai) #16

Hi Hemant,

I completely agree that forex losses could definitely hit it again. However, if you look at 2008-09 forex losses, ARBL had foreign currency loans (short term and long term) of roughly 110 crores which is no longer there. So, forex loss would be moderate in % terms. Now that one is looking at forex losses, one must also consider a possibility of forex gain too, if ruppe appreciates. In my opinion, from 55 levels with Government measures on fiscal consolidation and reform process, odds of rupee appreciating is higher than that of sharp depreciation. With respect to price war, I agree that Exide can take aggressive stance and cut prices leading to lower margins. However, following interview from management provides a good pointer that ARBL wants to decouple its pricing from that of its competition. I think, it does indicate they are getting good hold in the market. Following are the links of management’s take on business/pricing and FY 13 forecast.

http://www.moneycontrol.com/news/results-boardroom/amara-raja-eyes-double-digit-revenue-growthfy13_710347.html Link: http://www.moneycontrol.com/news/results-boardroom/amara-raja-eyes-double-digit-revenue-growthfy13_710347.html

http://www.moneycontrol.com/news/business/amara-raja-hopeful15-18-topline-growthfy13_749583.html Link: http://www.moneycontrol.com/news/business/amara-raja-hopeful15-18-topline-growthfy13_749583.html

In terms of returns,unfortunately I don’t have crystalball! :slight_smile: I see company’s earninggrowing at 20% CAGR in next 5 years and if that happens with fantastic return ratios, management quality and business moat, I don’t see why company can not command 18-20 P/E. So may be 3-4 bagger from here.

Best Regards

Dhwanil Desai


(Dhwanil Desai) #17

Hi Ninad,

With respect to margins, at least the management interview indicates that margin improvement was volume driven (which i interpret as better capacity utilization). Also at least for FY 13, management expects margin of 15-18%. However, in the longer term I concur that it will return to 14-15% level. However, following interview by management looks interesting to me. Management is saying that beyond a certain point, they want to delink their pricing with that of competitor! sounds very intersting. Does it indicate edge over competition and absolute pricing power? is it possible to turn intents into actions when time comes? I really don’t know but would like to closely watch this variable as it will give fair sense on widening moat.

In terms of how ARBL has dented once monopoly of Exide, I would like to point out one differniator as Technology. ARBL, due to its ties with Jhonsons Control was able to bring cutting edge technology to India (VRLA, Silver Line) which was instrumental in it gaining market share in industrial segment. Exide, having operated for years in monopoly, was slow on technlogy development. It is slowly catching up, but with Jhonsons Control on ARBL side, I see a clear edge for ARBL on that front.

However, irrespective of this edge, I find inherent business economics very attractive for the industry due to scale/reach + brand that needs to created to compete. Barrier to entry are high as it will take years to create strong brands and reach. Moreover, on the industrial side battery is a critical component hence “provenness” is a key factor in buyin decision. So if railways is operating its 2-3 tier AC coaches powered by batteries, they better be sure about the performance of the battery.So, I feel there is definitely some moat whichcan protect its returns for reasonably long time.

Best Regards

Dhwanil Desai


(Hitesh Patel) #18

If one looks at the whole market and tries to find out a company with “sustainable moat”, with great balance sheet, good future potential and at reasonable valuations, ARBL would rank among the top companies in terms of attractive buy at cmp even after the recent run up.

I think this is a company for keeps in a long term portfolio. too much analysis might lead to paralysis. At a market cap of 3200 odd crores the addressable market size for the company is huge. Exide is almost four times it in terms of market cap. And battery market is going to keep on growing at a steady 15-20% rate over the years as one needs to keep on replacing the batteries every 3-4-5 years. One just has to see the traffic on roads to gauge the demand for batteries.

disc: No positions currently but in all likelihood might add to the portfolio.


(hemant gupta) #19

hiteshbhai,

you mentioned ARBL would rank among the top companies in terms of attractive buy at cmp with sutainable moat, potential. what other companies come to your mind when you think about these features?


(Abhishek Basumallick) #20

I have been alternately looking at Astral, Mayur, Kaveri and ARBL in the last week. And my first impression is that this is an excellent company to invest in. Let me tell you why I really started looking at it. A few weeks back Rudra (also on Valuepickr) and he mentioned this. A couple of days later my car battery needed replacement and I went to the battery store which is about 100 mtrs from my house. It happens to be a Exide dealership. My existing factory-fitted battery was a Amaron. I fitted a Exide :slight_smile: The owner of the store told me that why don’t you buy a Amaron, they are better!!! Later I asked him if he was an Exide dealer why was he suggesting Amaron, he said his son owned a Amaron dealership and the products are better. This actually was eye opening for me. This guy has seen the industry for likely over 30-40 years and has incentives to sell Exide but is suggesting Amaron, then the product must surely be better.

Then I looked at the stock, and nothing that I have seen, makes me skeptical. Looks like a lambi-race-ka ghoda to me.

Disclosure: No positions yet. Definitely will buy so views are biased.