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Technological disruption to weigh on valuations…

Amara Raja Batteries (ARBL) reported steady Q4FY21 results. Net sales rose 33% YoY, 7.3% QoQ to | 2,103 crore. As per management commentary, demand during the quarter was strong across all automotive and industrial segments. Margins were at 15.1% (down 50 bps QoQ) amid 130 bps gross margin contraction and increase in other expenses on percentage of sales basis. PAT grew 39% YoY (down 2% QoQ) to | 189 crore. ARBL declared a total dividend of | 11/share for FY21.

Aftermarket to stabilise near-term sales, margin performance

ARBL has significant exposure to the aftermarket channel (forms ~65% of automotive segment, which constitutes ~70% of overall revenues). Courtesy healthy OEM industry performance in FY17-19 and ~two to three years blended replacement cycle in automotive battery space, aftermarket channel is set to continue to impart an element of stability to ARBL’s topline for FY22E. The same is seen benefitting blended realisations and margins on account of better pricing power in the channel (B2C business, near duopoly market in organised space). However, in FY21-23E, OEM channel is seen outperforming as production ramps up once effects of the ongoing second pandemic wave taper off.

Consequent mix deterioration, along with uptick in commodity cost inflation (ARBL gross margins have contracted ~210 bps over H2FY21) are seen pressurising margins over the medium term. The company has recently outlined capex towards 50 MW solar power plant (| 220 crore) and greenfield lead recycling (| 280 crore), which are seen lowering production costs in a back-ended manner. We build 11.6% revenue CAGR in FY21-23E. Margins are seen dipping to 14.1% in FY22E before climbing to 14.7% in FY23E amid operating leverage benefits.

Electric future to constrict addressable market

The domestic lead acid battery space is set to witness substantial disruption in coming years as India increasingly encourages green mobility. While the transition away from fossil fuel-powered transport is set to be fairly gradual, addressable market for incumbent lead acid ecosystem would shrink, thereby throwing up both an opportunity as well as a challenge to players like ARBL.

At present, ARBL has set up a lithium-ion technology research hub with pilot plant facility for cell development and has pack assembly capabilities for industrial and automotive use. ABRL can potentially benefit from the recently announced | 18,100 crore PLI scheme for advance cell chemistry if it ramps up efforts to address this opportunity. However, we await affirmative action from ABRL on this front, before turning decisively positive on the company’s long term demand prospects.

Valuation & Outlook

We expect 7.4% FY21-23E PAT CAGR for ARBL. While the company currently trades at reasonable valuations, we maintain our REDUCE rating, valuing it at | 700 i.e., 16x FY23E EPS (earlier target price | 800) on account of (a) expected softening of margin profile and (b) imminent EV threat.

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