Friday, October 31, 2014

>Exide Industries Limited: 2QFY15 RESULTS REVIEW (ANTIQUE)

Margins set to recover from 3Q itself

Exide Industries' (EXID IN) 2QFY15 adjusted earnings rose 6% YoY but was down 32% QoQ to INR1.3bn, way below consensus estimates of INR1.5bn. Margins fell 340bps QoQ and 230bps YoY to 11.8%, due to weaker scale, larger fuel and freight costs, and higher technology upgradation-related expenses. On account of weak seasonality in industrials, revenue contraction was broadly in line with estimates, down 8% QoQ to INR17.6bn. An 80bps QoQ decline in gross margins and higher other expense, as a percentage to sales, of 170bps QoQ led to a negative surprise in terms of EBITDA margin at 11.8% as against expected levels of ~14%.

We leave unchanged our revenue and margin estimates for FY15e/FY16e, factoring a revenue CAGR of 19% over FY14-16e, on the back of low base in industrials in FY14 and a cyclical recovery in the original auto equipment manufacturer segment. We also retain our margin estimates at 14.4%/15.2%
for FY15e/FY16e, respectively. On the back of a cyclical recovery in the automotive segment, leading to better scale; price hikes in the inverter segment by ~5%; and incremental 10% correction in lead prices over 1Q levels to ~USD2,000 per tonne, we are confident of EXID achieving over 15%
margin levels by 4QFY15 itself. The management is guiding at a capex of INR5.5bn over FY15-16e to enhance automation, technology, and capacity in some segments. After incurring losses in FY14, due to currency volatility, the smelter subsidiaries are expected to improve profitability in FY15e, thus contributing to consolidated earnings. The company's insurance business had already turned profitable in FY14, with a PAT of INR0.5bn. It is expected to improve its performance further this fiscal.

We upgrade the stock to Buy but maintain our price target at INR179 per share, based on 17x FY16e battery business EPS of INR9.8 and value the insurance business at INR13 per share. With capital efficiency recovering to over 20%; strong earnings visibility of ~31% CAGR over FY14-16e, led by
demand recovery across segments and stable margins ~15%, we do not foresee any reason for EXIDE to trade at a significant discount to its long-term mean traded core earnings multiple of 18x.

Key takeaways from the management interaction:
􀂄 Price hike of 5%, effective November, in the inverter segment, presently contributing close to 30% of overall revenues, to drive partial margin recovery next quarter. A QoQ decline of ~10% in lead would get reflected in gross margin from 4Q onwards. Drop in crude prices is set to partially impact raw material prices, as other than lead, crude derivatives too form a chunk of raw material expenses for manufacturing battery casings.
􀂄 Drop in diesel prices will reduce freight expenses in addition to other fuel-related expenses at the plant level. The management is focusing on reducing charging-related expenses too going forward. Technology upgradation-related expenses will increase the element of automation. Productivity improvement has risen this quarter in the form of consultancy charges and is set to persist for a few additional quarters. The company is also trying to reduce its lead content per battery to improve margins down the line. It is targeting a
250bps structural improvement in gross margins over the next two-to-three years.
􀂄 The management is content with its present market share in the replacement market and looking forward towards margin improvement strategies like controlling dealer incentives. It does not foresee any major price war with its largest competitor, which is adding new capacity in the coming quarter. EXIDE broadly operates at 83% and 79% utilisation in the two- and four-wheeler segments, respectively.
􀂄 The company is confident of achieving 15-17% margin in FY16e, and would move towards that trajectory from next quarter itself. Despite 3Q being another weak quarter for industrials, the management is certain of a substantial improvement in margins. In the longer run, we do not see any hurdles towards a low double-digit sustainable growth in the auto battery replacement market.

We upgrade EXID to Buy from Hold, leaving our price target unchanged at INR179 per share, based on 17x FY16e core business earnings and value the insurance business at INR13 per share. With visibility of enough drivers for margins to recover from the seasonally weak level of 11.8% back towards 15%, we leave our margin estimate unchanged at 15.2% for FY16e, amid a cyclical recovery in overall volumes.