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Backward integrates by acquiring plastic component business from promoter entity, await larger Li-On play

About the stock: Amara Raja Batteries (ARBL) is a part of the duopolistic organised Indian lead acid battery market with a strong presence across automotive (OEM and aftermarket) and industrial battery space (UPS, telecom, solar, etc).

* Geographical mix as of FY22: Domestic ~87%, Export ~13%

Key Highlights:

* Demerging plastic component for battery business of Mangal Industries (MIL) (unlisted promoter entity) and merging it into ARBL (listed entity) for a swap ratio of 65 equity shares of ARBL for every 74 equity shares of MIL. Total ARBL shares to be issued to promoters for acquiring this business is pegged at 1.22 crore shares (acquisition value at CMP ~| 592 crore). Post this, promoter holding in ARBL will increase from 28.1% to 32.9%

* Demerged entity currently generates ~| 570 crore of revenue (FY22) with EBITDA pegged at | 98 crore (EBITDA margins at 17%) and PAT at | 57 crore (PAT margins at 10%) with ARBL being its sole customer

* Consequent valuation at which it is being acquired is derived as ~1x P/S, ~10x P/E and ~7x EV/EBITDA and is expected to be EPS and margin accretive from first year itself. The company also informed about | 5-6 crore of post-tax saving (synergies) due to this backward integration

* We view this transaction as fair from the minority shareholder’s perspective and expect it to contribute positively to ARBL financials, going forward

What should investors do: ARBL’s share price has declined at ~7.4% CAGR from ~| 710 in September 2017 thereby underperforming the Nifty Auto index in that time.

* We upgrade the stock from REDUCE to HOLD given margin accretive nature of this acquisition but await further affirmative actions in the Li-On battery space before turning decisively positive on the company

Target Price and Valuation: Without altering our financial estimates of base business, we now value ARBL on SOTP basis incorporating the PAT of the new plastic business. We now value ARBL at | 500 i.e. 13x PE on FY24E (earlier TP | 475).

Key triggers for future price performance:

* With double digit OEM volume growth in offering, benign RM price outlook we expect sales, PAT to grow at 14%, 11%, respectively, CAGR in FY22-24E

Alternate Stock Idea: Besides ARBL, in our auto OEM coverage we like M&M.

* Focused on prudent capital allocation, UV differentiation & EV proactiveness

* BUY with target price of | 1,590

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