Amara Raja Batteries (AMARAJ) CMP: | 630 Target: | 590 ( -6%) Target Period: 12 months REDUCE May 16, 2019 Subdued performance; growth a concern… Amara Raja Batteries (ARBL) reported a muted set of Q4FY19 numbers. Revenues were at | 1,567 crore (down 0.9% YoY). EBITDA rose 14.9% YoY to | 242 crore with attendant EBITDA margins at 15.5%, up 54 bps Particulars sequentially. ARBL enjoyed significant gross margin expansion on both YoY (353 bps) and QoQ basis (203 bps), mitigated by an increase in employee Particular Amount costs & other expenses. Consequent reported PAT rose 8.7% YoY to | 119 Market Capitalization | 10761 Crore Total Debt (FY19P) (| crore) 46.8 crore. ARBL declared a final dividend of | 5.08/share for FY19. Cash & Investments (FY19P) (| crore) 72.0 EV (FY19P) | 10735.8 Crore Result Update Result Replacement demand, benign lead prices to support! 52 week H/L (|) 908 / 610 Equity capital (| crore) 17.1 ARBL’s segment mix was at ~75% automotive and ~25% industrial. Face value (|) | 1 Replacement demand forms a lion’s share of automotive demand at ~70% while OEM demand makes up the rest. The auto OEM space has been Key Highlights witnessing muted demand since Diwali, thereby having a knock-on impact on ancillary players including battery makers. OEM demand is expected to Revenue growth for Q4FY19 below expectations. FY19 revenue (up remain subdued in the next few quarters amid vast regulatory changes 12.1% YoY) impacted positively by (ABS, BS-VI) and general slowdown in consumer discretionary expenditure. by 2-W & 4-W replacement demand However, for battery manufacturers, the replacement market would and inverter segment while OEM continue to provide steady state demand, especially in view of robust OEM segment was a laggard sales seen during the past few years, thus driving revenue growth. Steady replacement demand and benign lead prices to support future Concurrently, margins at battery players including ARBL would benefit from growth moderation in lead price (currently ~US$1850/tonne vs. Q4FY19 average ~US$2050/tonne). We build in ~7.3% CAGR in battery volumes and ~220 Termination of technology agreement with Johnson Controls bps improvement in EBITDA margins over FY19-21E. However, our topline increases uncertainty growth is pegged at 0.3% CAGR due to sharp 15%+ decline in lead prices. Downgrade to REDUCE with revised target price of | 590 Technology agreement termination lends uncertainty! In April 2019, ARBL and erstwhile technology partner Johnson Controls (JC) ended their long standing agreements related to shareholding and technical Research Analyst assistance & licensing consequent to JC’s exit from its global power Shashank Kanodia, CFA Research Equity Retail [email protected] solutions business. Also, 2% of JC’s stake was bought by the Galla family – with the resulting shareholding now at 28% (Galla Family) & 24% (JC). While Jaimin Desai ARBL has in the past assimilated all technology from JC, the agreement [email protected] termination raises concerns over future innovation at the company. Thus, it increases uncertainty in what is going to be disruptive times for battery makers, going forward, with increasing thrust on lithium ion adoption. Valuation & Outlook Securities ICICI We expect sales, EBITDA and PAT to grow at -0.4%, 8.3% & 7.5% CAGR, respectively over FY19-21E. With the slowdown in the auto OEM space amid a decline in discretionary spend and muted growth prospects in the industrial domain (telecom space), we downgrade the stock to REDUCE with a revised target price of | 590 i.e. 18x P/E on FY21E EPS of | 32.7 /share. Key Financial Summary Key Financials FY17 FY18 FY19P FY20E FY21E CAGR (FY19P-21E) Net Sales 5,317.2 6,059.2 6,793.1 6,202.1 6,744.5 -0.4% EBITDA 849.9 883.2 951.8 1,016.2 1,115.4 8.3% EBITDA Margins (%) 16.0 14.6 14.0 16.4 16.5 Net Profit 478.5 471.3 483.5 511.8 559.2 7.5% EPS (|) 28.0 27.6 28.3 30.0 32.7 P/E 22.5 22.8 22.3 21.0 19.2 RoNW (%) 18.5 16.0 14.5 13.9 13.7 RoCE (%) 25.8 23.3 21.2 20.2 20.0 Source: ICICI Direct Research, Company Result Update | Amara Raja Batteries ICICI Direct Research Exhibit 1: Variance Analysis Q4FY19 Q4Y19E Q4FY18 YoY (%) Q3FY19 QoQ (%) Comments Revenues for the quarter came in below our estimates Total Operating Income 1,567 1,715 1,581 -0.9 1,695 -7.5 primarily indicating some loss of volumes by the company vs. competition Raw Material Expenses 1,022 1,145 1,087 -6.0 1,139 -10.3 Employee Expenses 82 86 78 4.1 87 -5.9 Other Expenses 221 218 205 8.0 216 2.6 EBITDA 242 267 211 14.9 253 -4.2 Gross margin expansion on QoQ and YoY basis mitigated EBITDA Margin (%) 15.5 15.6 13.3 212 bps 14.9 54 bps by increase in both other expenses as well as employee costs Other Income 6 15 24 -73.3 13 -49.4 Depreciation 68 67 59 16.1 66 4.0 Depreciation came in on expected lines Interest 2 2 1 41.2 2 3.4 Tax 59 71 64 -8.7 67 -12.0 Lower than estimated topline resulted in PAT being lower- Reported PAT 119 142 110 8.7 131 -8.8 than-expected EPS (|) 7.0 8.3 6.4 8.7 7.7 -8.8 Key Metrics Sales (| crore) 1,567 1,715 1,581 -0.9 1,695 -7.5 RM cost (% to net sales) 65.2 66.7 68.7 -353 bps 67.2 -203 bps Gross margins expanded encouragingly 200 bps QoQ Lower sales leads to optically high employee costs as a Other expenses (% to net sales) 14.1 12.7 13.0 116 bps 12.7 140 bps percentage of sales Employee Expense (% to net sales) 5.2 5.0 5.0 25 bps 5.1 9 bps Source: Company, ICICI Direct Research Exhibit 2: Change in estimates FY20E FY21E (| Crore) Old New % Change Introduced Comments Revenues revised lower for FY20E, on account of slowing OEM sales in auto space Revenue 7,816 6,202 -20.6 6,744 and sharp decline in lead prices with consequent transmission of same to end customers (selectively). Introduce FY21E numbers EBITDA 1,109 1,016 -8.4 1,115 We expect gross margins to expand primarily tracking lower lead prices. Over FY19- EBITDA Margin (%) 14.2 16.4 220 bps 16.5 21E, we build in 250 bps expansion in EBITDA margins PAT 595 512 -14.0 559 Lower sales lead to downward revision in EPS estimates for FY20E. Introduce FY21E EPS (|) 34.8 30.0 -14.0 32.7 numbers Source: Company, ICICI Direct Research ICICI Securities | Retail Research 2 Result Update | Amara Raja Batteries ICICI Direct Research Financial story in charts Exhibit 3: Topline trend 8,000 6,793 6,744 7,000 6,059 6,202 We expect sales to be largely flat over FY19-21E, 6,000 5,317 albeit supported by steady state replacement 4,618 demand. We build in battery volume CAGR of ~7%. 5,000 4211 However, it is dragged by a sharp decline in lead 4,000 3,437 (| crore) (| prices to the tune of ~15%+ 3,000 2,000 1,000 0 FY14 FY15 FY16 FY17 FY18 FY19P FY20E FY21E Source: Company, ICICI Direct Research Exhibit 4: Profitability trend 800 10.6 12 700 9.8 9.0 10 8.3 8.3 600 7.8 7.1 8 We factor in 7.5% PAT CAGR at ARBL over FY19-21E 500 to | 559 crore 400 6 300 4 200 2 100 411 492 478 471 483 512 559 0 0 FY15 FY16 FY17 FY18 FY19P FY20E FY21E PAT (| crore) PAT margin (%) (RHS) Source: Company, ICICI Direct Research Exhibit 5: Return ratio profile 45.0 36.6 36.0 32.6 32.5 Return ratios trend on a decline tracking muted sales 27.0 25.8 23.3 21.2 20.0 and PAT growth. It is, however, still at comfortable (%) 20.2 27.2 23.2 level of ~20% as RoCE 18.0 23.3 18.5 13.7 9.0 16.0 14.5 13.9 0.0 FY14 FY15 FY16 FY17 FY18 FY19P FY20E FY21E RoCE RoNW Source: Company, ICICI Direct Research ICICI Securities | Retail Research 3 Result Update | Amara Raja Batteries ICICI Direct Research Exhibit 6: Valuation Summary Sales Growth EPS Growth PE EV/EBITDA RoNW RoCE (| cr) (%) (|) (%) (x) (x) (%) (%) FY17 5317.2 15.1 28.0 -2.7 22.5 12.5 18.5 25.8 FY18 6059.2 14.0 27.6 -1.5 22.8 12.0 16.0 23.3 FY19P 6793.1 12.1 28.3 2.6 22.3 11.0 14.5 21.2 FY20E 6202.1 -8.7 30.0 5.9 21.0 10.2 13.9 20.2 FY21E 6744.5 8.7 32.7 9.3 19.2 9.1 13.7 20.0 Source: Bloomberg, ICICI Direct Research Exhibit 7: ARBL currently trading at 19.2x its two-year forward expected EPS 1400 1200 1000 800 (|) 600 400 200 0 Feb-10 Feb-12 Feb-15 Feb-17 Feb-11 Feb-13 Feb-14 Feb-16 Feb-18 Feb-19 Nov-09 Nov-11 Nov-14 Nov-16 Nov-10 Nov-12 Nov-13 Nov-15 Nov-17 Nov-18 Aug-11 Aug-13 Aug-16 Aug-18 Aug-09 Aug-10 Aug-12 Aug-14 Aug-15 Aug-17 May-10 May-13 May-15 May-16 May-18 May-09 May-11 May-12 May-14 May-17 May-19 Price 40x 34x 29x 23x 18x 12x 7x Source: Reuters, ICICI Direct Research ICICI Securities | Retail Research 4 Result Update | Amara Raja Batteries ICICI Direct Research Exhibit 8: Recommendation history vs.