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EBITDA below estimates; cost pressures to continue; maintain Hold

* Q2 EBITDA declined by 21% to Rs2.7bn, 5% lower than estimates due to the delay in passing on commodity inflation to customers, higher warranty expenses, and a temporary increase in power costs. Revenue grew by 17% to Rs22.6bn (est.: Rs21.3bn), above estimate on better-than-expected revenues in the replacement and industrial segments.

* We believe that growth in the replacement segment will normalize in the coming quarters. The product mix is likely to be adverse in FY23-24E due to the reducing share of the highmargin replacement segment.

* We cut FY22E/23E/24E EPS by 9%/4%/3% to Rs38.4/Rs49.8/Rs57.2 on lower margin assumptions. Lead prices have increased sharply by over 40% in the last five quarters. The company has been passing on the impact in a staggered manner, with some lag.

* Taking into account the expectations of a shrinking share of the lead-acid battery segment and sub-par returns from new investments in lithium batteries in the initial years, we retain our Hold rating on the stock. Our DCF-derived TP Dec’22 stands at Rs775 (Rs830 earlier), based on 14x Dec’23E EPS (15x Sep’23E earlier).

EBITDA margin above estimates: Revenue grew by 17% yoy to Rs22.6bn (est.: Rs21.3bn) and came in above estimates. The replacement segment has done well, with volume growth of 20% in 2Ws and 12% in 4Ws. The industrial segment also witnessed 10-12% growth. However, the OEM segment’s performance was muted, with flat growth in 2Ws and 5-6% growth in 4Ws. EBITDA declined by 21% to Rs2.7bn, 5% lower than estimate on lower gross margins and higher other expenses. The company indicated that the delay in passing on commodity inflation to customers, higher warranty costs, and a temporary increase in power tariffs in the state of Andhra Pradesh led to higher costs. EBITDA margin contracted by 570bps to 11.9% (est.: 13.3%). Thus, PAT declined by 28% to Rs1.4bn (est.: Rs1.5bn), below estimate due to lower operating profits. The company is working on its new energy strategy to participate in emerging opportunities in new chemistries and has started lithium battery pack supplies for 3Ws (revenue of Rs200mn in the quarter).

Maintain Hold: Considering the risk of technology disruption in the battery space, we retain our Hold rating on the stock. Our TP is derived using a DCF methodology and stands at Rs775, based on 14x Dec’23E EPS. We reduce our valuation multiple, considering the declining share of the lead acid battery segment due to increasing EV penetration. We factor in lower growth in our DCF model in the next 10 years while reducing our terminal growth to 2% from 4.5% earlier.

Key upside risks: Higher-than-expected demand in Automotive and Industrial segments and a benign currency/commodity environment. In addition, the longterm usage of lead-acid batteries as auxiliary batteries in E-4Ws is uncertain, as recently global OEMs, such as Tesla, have replaced auxiliary lead-acid batteries with lithium-ion batteries. However, if the demand continues, it could provide some upside to the company’s long-term growth.

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