Stock Review: Exide Industries

Kolkata-headquartered Exide Industries is the leader in the Indian battery market. The company's competitive advantages arise from its strong brand, wide distribution reach, and its ability to keep raw material costs low through in-housing sourcing of its key input, which is lead.

Exide earns 62 per cent of its revenue from the automotive segment and 38 per cent from the industrial segment. Within the automotive segment, the replacement market contributes 73 per cent of its revenues while the original equipment market (OEM) segment contributes 27 per cent. In the industrial segment, most of its revenue (72 per cent) comes from the sale of power backup systems like UPS and inverters. The company owns six manufacturing plants spread across the country.

 

Industry dynamics

In the Indian battery market, organised players have 65 per cent market share while unorganised players account for 35 per cent. The organised battery market in India is expected to grow at a compounded annual growth rate (CAGR) of around 20 per cent over the next five years.

The country's two biggest battery manufacturers are Exide Industries and Amara Raja. In the OEM segment, Exide enjoys 70 per cent market share while Amara Raja holds 26 per cent. In the replacement segment, Exide holds 68 per cent share and Amara Raja, 26 per cent. The industrial segment is dominated by three players: Exide, Amara Raja, and Hyderabad Power Systems.

 

Sources of economic moat

Exide enjoys strong brand loyalty, which in turn gives it a lot of pricing power.
Another source of competitive advantage for the company is the formidable distribution network that it has built over the years. Exide's distribution network is more than twice as large as that of Amara Raja. While it has access to 38,500 retail outlets (including 12,500 dealers spread across 202 cities), Amara Raja has access to only 18,000 retailers.

The industry's duopoly structure (the top two players account for more than 90 per cent of the organised market) gives a lot of pricing power to Exide. According to analysts at Kotak Institutional Equities, this industry structure is unlikely to change over the next five years — a fact that will ensure that the company's high margins remain intact over the medium term.

Another strength of the company is the strong relationship that it has built up with OEMs over the years. Exide's strength also lies in the fact that it sources about 45 per cent of its lead requirement (lead is the key input in battery manufacturing) from captive smelters, while the comparable figure for Amara Raja is only 20 per cent. This gives the former a cost advantage since lead sourced from captive smelters costs 7-8 per cent less than imported lead. The company owns 100 per cent stake in two lead smelters: Chloride Metals and Leadage Alloys. In FY09 it sourced only 23 per cent of its lead requirements from in-house smelters, but by the end of FY13 it aims to increase this figure to 70 per cent.

At the end of FY10, its smelter capacity stood at 96,000 tonnes. The company plans to raise it to 1,40,000 tonnes by FY12.

Another competitive advantage of the company arises from its in-house research and development capabilities. The company recently custom-designed a battery for the Nano and is currently working on batteries for hybrid vehicles. It has technological tie-ups with several Japanese and Chinese companies.

 

What could cause moat to be breached

Given Exide's large market share (70 per cent in OEM segment and 68 per cent in replacement market), its strong brand equity, and its overwhelming distribution strength, it appears unlikely that its moat will be breached soon. Global players like GS Yuasa and Exide Technologies of US (unrelated to Indian Exide) have tie-ups with Tata Autocomp and Tudor India respectively, but they have not been able to make large inroads into the market. Hence analysts expect the Indian battery market to remain a duopoly in the near future.

 

Growth drivers

Strong demand. The automobile industry in India has been witnessing robust growth in recent years: between 2005 and 2010, the two-wheeler segment grew at a CAGR of 9.8 per cent; passenger vehicles at 14.3 per cent; and commercial vehicles at 10.6 per cent. This growth is likely to continue in future as well due to low current penetration and rising income levels.
The automotive battery market is expected to more than double in size from `84 billion in FY10 to Rs 201 billion by FY15.

Another key growth driver is the shifting of customers from unorganised brands to organised brands in the replacement market, due to the higher quality and lower life-cycle costs of the latter.

Stable margins. The company's margins are expected to remain stable due to a number of reasons: one, the duopoly structure of the battery market gives it strong pricing power. The company has price escalation clauses (based on rise in input prices) written into its agreements with OEMs. Two, from 45 per cent in FY11, the company expects to source nearly 70 per cent of its lead requirements from in-house smelters, which will result in cost saving. And three, the replacement segment, where margins are higher, is expected to grow faster than the OEM segment. Between FY11 and FY13, the replacement battery segment is expected to grow at the rate of 20 per cent CAGR.

Augmenting capacity. The company plans to increase its capacity for four-wheeler batteries from 10.6 million in March 2011 to 12 million by October 2011. It also plans to increase its capacity for two-wheeler batteries from 10 million in March 2011 to 21 million by the end of FY13. The company is developing a new plant at Ahmednagar. Higher capacity will enable it to take full advantage of rapidly rising demand.

 

Concerns

Capacity constraint. In recent quarters, the company has been operating at peak capacity utilisation. Owing to high demand from the OEM segment, it has been unable to supply adequately to the replacement market, where margins are higher. Margins in the replacement segment are around 25 per cent while they are only 5-7 per cent in the OEM segment. This has affected the company's profitability. But this problem will get solved as more capacity becomes operational.

Slower growth in industrial battery segment. The company manufactures power backup systems (UPS and inverters), telecom batteries (used in base stations of telecom towers), and also supplies to the power sector and to railways.

Between FY09 and FY11, the demand for industrial batteries slowed down to a CAGR of 10 per cent. This was due to the slower proliferation of telecom base stations, excess capacity for telecom batteries, and hence aggressive price competition in this segment. Analysts at Kotak Securities expect the industrial battery segment to grow at 14 per cent annually between FY11 and FY13.

Rising raw material costs. Lead accounts for 80 per cent of total raw material costs while plastic resins account for 18 per cent. The company has lead price escalation clauses built into its contracts with OEMs. In the replacement segment, it enjoys strong branding power which allows it to hike prices (it took a 3 per cent hike in January 2011). Sourcing of lead from captive smelters also affords it greater protection against increasing price of lead.
Despite these advantages, a steep increase in the price of lead will affect Exide's margins.

Losses in life insurance business. Exide holds a 50 per cent stake in ING Vysya Life. This business started operations in September 2001 and has been loss-making since. The company has so far invested Rs 630 crore into it. A potential risk to Exide's future earnings arises from greater-than-expected losses in the life insurance business.

 

Financials

Over the last five years, the company's income has grown at a CAGR of 26.39 per cent while PAT has increased at 44.97 per cent. It has maintained a high return on equity (RoE) of 35.43 per cent over this period. The company has a miniscule debt-to-equity ratio of 0.04.

 

Valuation

The company is trading at a 12-month trailing PE ratio of 19.4, which is lower than its five-year median PE of 21. Over the last five years its earnings per share (EPS) has grown at a CAGR of 43.38 per cent, which gives it a price-earnings to growth (PEG) ratio of 0.47. Invest in this stock with at least a three-year investment horizon.