Jigar Shah

It would not be an exaggeration to state that Exide Industries is the country’s largest battery-maker, straddling three key verticals — original equipment (OE) automotive, replacement market and the industrial segment. It rules the OE market with close to 70% share and holds around 40% share in the replacement market. It produced 27 million auto batteries in FY14 and 1,771 mAh of industrial batteries.

All leading automobile manufacturers, domestic and foreign, are its clients. In the industrial segment, Legrand, Emerson, L&T, and ABB are its big clients. In the telecom segment, all leading telecom players use Exide products. The company has managed to stay abreast technologically as well thanks to multiple partners, including East Penn of the US and Shin-Kobe and Furukawa of Japan. 

In FY14 the automotive segment formed 65% of its revenue with the balance coming from the industrial segment. Within the automotive revenue, Exide derives 71% of its business from the replacement market and the rest from the OE equipment supply.

In other words, it does not have to rely on incremental auto sales to drive its business. In the industrial segment, 64% revenue comes from the power-back or inverter/UPS segment, 24% from infrastructure and the rest from other sectors such as solar. For the past five years, Exide’s revenue increased at a CAGR of 12% and its profit before tax rose at a CAGR of 11% for the same period.

Well-entrenched

One of the strong points of Exide’s manufacturing set-up is its captive lead smelting and refining facilities (40% of its supplies are met through captive sources). This gives it a cost advantage because lead, which is its major raw material, is imported and volatility in lead prices is one of the biggest challenges for battery-makers. Further, the company has eight plants across India, catering to a diverse clientele with the most efficient logistics and distribution network in place.

Another feature of Exide’s strength is its dealer network — 13,000 dealers for automotive, 10,000 for industrial and 2,000 for other batteries. Its products reach over 42,000 outlets and it has over 200 service stations to aid its customers.

Bumpy ride

Despite such a dominant presence, Exide’s financial performance has been less than impressive in the past three years. This is due to a) capacity creation ahead of time and increased cost of production b) demand slump in the industrial segment and c) price discounting and volatility in the inverter battery segment. During this period, Exide’s operating margins fell from a peak of 17% to 13%.

A recovery has already begun and will accelerate over the next two years. We believe that the time is changing again in favour of Exide owing to various factors and it can get back to its peak operating margin by next year. Exide reported a better financial performance and for 1HFY15, took a price increase in the automotive OE segment. Its capacity utilisation, too, improved, resulting in an improved margin in the first quarter. The second-quarter margin fell due to seasonally low sales of inverter batteries: inverter batteries usually sell more in the first and fourth quarters due to seasonal factors.

Revving up

The automotive industry is already improving this year and is likely to report a 10% volume increase against very low-to-flat growth for the past two years. Exide will be a big beneficiary of this demand recovery because of its operating leverage. As its utilisation rises above the 65-70% level, it will aid margin expansion. A strong growth in automotive demand will also strengthen demand in the replacement market in the following years, the most profitable segment for Exide, forming 40% of its total revenue. A recovery in truck demand will also boost margins because truck batteries sell at a much higher price than car batteries.

The second margin lever for Exide will be its recent efforts to increase manufacturing efficiency through its collaboration with East Penn, Furukawa, etc. Compared with its nearest competitor, Exide has more plants, with some legacy issues attached with its productivity, which it is now trying to resolve. Exide’s capex plan of ₹4.5 billion for FY15 revolves around reducing the size of batteries through better design, automation and reducing wastage. The third margin lever for Exide will be a recovery in the industrial segment. It has entered the telecom battery segment that it had exited a few years ago. A revival in power and other industrial projects and defence production will also boost prospects for Exide because it has 70-80% share in those segments.

Undervaluation unjustified

Another piece of value in Exide is its wholly-owned life insurance business, in which it has already invested ₹12 billion; it also owns lead smelting and refining facilities. We expect a strong recovery in Exide’s earnings over the next two years by 35% per annum to touch ₹10.5. We have valued Exide at ₹206 based on 18X its core earnings (₹190) and its insurance business at book (₹16). The passage of the new insurance bill in Parliament, resulting in an increased foreign holding of 49% against the current 26%, will provide a good opportunity for Exide to monetise its investment by bringing in a foreign partner. Exide continues to maintain over 30% dividend payout and monetisation of investments will give it an opportunity to increase it further.

Despite its leadership in the battery sector and a clear lead over Amara Raja Batteries, its valuation trails the latter. Going by the annualised HIFY15 results of Amara Raja, it trades at a 30X estimated FY15 earnings and 17X Ebidta multiple. In contrast, Exide trades at a 23X estimated FY15 earnings and 14X Ebidta multiple, including its investment insurance business. 

The author of this report does not hold this stock in his personal capacity. However, he has recommended this stock to clients of Kim Eng Securities India, for which he works as head of research. [Exide is part of the Rajan Raheja group, which also owns Outlook Publishing.]