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Safal Niveshak StockTalk: Amara Raja Batteries

Statutory Warning: This report may cause a reaction, and acting on it can be injurious to your wealth.

Read any legendary investor on his key rules of picking up great stocks, and a parameter that will stand at the top of the list will be to seek out companies that have no or less competition, and operate in an environment that allows for steady and rising sales, profits, margins, and return ratios.

Such companies are far and few to be found in a hyper-growth, hyper-competitive, and hyper-entrepreneurial market like India.

Amara Raja Batteries Ltd. (ARBL) seems like one of those companies on the face of it. But does it really pass the test of a safe, profitable business from key angles that a sensible investor would look from?

What about the valuations? After all, even if a business is good, what determines an investor’s long-term returns is the price at which he buys that good business.

Let’s try to find all this by understanding ARBL’s business, the industry it operates in, factors that are working well for the company, and ones that can go wrong.

First, the Business
ARBL is India’s leading industrial and automotive battery maker, and is a joint venture between the Galla family (26% stake) and the US battery major Johnson Controls (26% stake).

It is the second largest manufacturer (after Exide) of valve-regulated lead-acid batteries (VRLA; also known as “sealed battery”) in India, and finds companies from the automotive (~50% of total revenue) and industrial (~50% of total revenue) sectors as its key customers. Its key battery brands include Amaron, PowerStack, Quanta, and PowerSleek.

As per its FY12 annual report, ARBL had…

  • 46% share of the Indian telecom batteries market (28% five years back)
  • 32% of UPS market (23%)
  • 26% of four-wheeler market (23%)
  • 19% of four-wheeler aftermarket or replacement market (12%)

In order to understand ARBL’s business deeper, it’s important for us to understand the nature of the oligopoly or duopoly market, which is characterized by just 2-4 firms competing against each other…like the Indian industrial and automotive battery market where ARBL and Exide are the two dominant players.

One of the economics models that studies the duopoly market is called the “Bertrand Model”, which suggests that, in a game of two firms, each one of them will assume that the other will not change prices in response to its price cuts.

In other words, firms compete by setting prices simultaneously and consumers want to buy everything from a firm with a lower price (since the product is homogeneous – like a car battery – and the consumer does not incur any costs in searching for the products).

If two firms charge the same price, consumers demand is split evenly between them.

Now, while this is not true of the Indian industrial and automotive battery market as of now – Exide has a much greater market share than ARBL – things are definitely looking to head in that direction. If t his were to really happen, it will be great for ARBL given that its market share will increase at the cost of Exide till both companies have an almost 50% share.

A crucial assumption of the Bertrand model is that both firms have the same constant unit cost of production, so that marginal and average costs are the same and equal to the competitive price.

My analysis of operating and margins of both ARBL and Exide suggest that thing do fit into these assumptions, as both companies have almost identical average operating and net margins over the past 5-6 years (though ARBL has witnessed some weakness off late owing to higher Lead prices, which I will cover later).

Now, from duopoly, let us understand a bit about oligopoly that also characterizes a very few firms competing against each other.

Here are a few key characteristics of the oligopoly model (text in italics is as per Wikipedia), and how the Indian automotive and industrial battery market stacks up on each of them…

1. Ability to set price: Oligopolies are price setters rather than price takers.

This seems to be working for ARBL and Exide, though only to a limited extent. As I will discuss below, the companies have not been able to pass through the entire raw material price hike to customers…and especially over the past 2-3 years owing to some squeeze from its large customers, especially in the automobile industry.

2. High entry and exit barriers: The most important barriers are economies of scale, patents, access to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or destroy nascent firms.

This is true for both ARBL and Exide. These two have been leading the industry for years now, with no meaningful competition from any other player.

Just ask yourself – in car batteries, you must have heard of just two brands – Exide or Amaron – and throughout the past.

3. Number of firms: “Few” – a “handful” of sellers. There are so few firms that the actions of one firm can influence the actions of the other firms.

This is also true of the Indian automotive and industrial battery market, where both ARBL and Exide seem to be tip-toeing the line, depending on what the other is doing. First ARBL caught up with Exide in terms of branding and reach…and now Exide is doing in terms of capacity expansion and technology upgradation.

4. Long run profits: Oligopolies can retain long run abnormal profits. High barriers of entry prevent sideline firms from entering market to capture excess profits.

This is great news for both ARBL and Exide. Given their relationships with leading automotive and industrial consumers, quality of their products, and the relatively low price of their products (compared to the consumer’s total product cost; a car battery costs just Rs 3,000-5,000), they are in a great position to earn good profits over the next many years.

5. Interdependence: The distinctive feature of an oligopoly is interdependence. Oligopolies are typically composed of a few large firms. Each firm is so large that its actions affect market conditions. Therefore the competing firms will be aware of a firm’s market actions and will respond appropriately.

It is very much like a game of chess or pool in which a player must anticipate a whole sequence of moves and countermoves in determining how to achieve his or her objectives.

For example, an oligopoly considering a price reduction may wish to estimate the likelihood that competing firms would also lower their prices and possibly trigger a ruinous price war. Or if the firm is considering a price increase, it may want to know whether other firms will also increase prices or hold existing prices constant.

Again, this is true in case of ARBL and Exide as we will understand in the analysis below.

6. Non-Price Competition: Oligopolies tend to compete on terms other than price. Loyalty schemes, advertisement, and product differentiation are all examples of non-price competition.

True again for ARBL and Exide. Both these companies have maintained prices close to each other’s products and largely compete on branding and special schemes for distributors and direct consumers.

Now, while this is great for ARBL because Exide will not be able to outperform it in terms of margins and growth in the long run, the negative side is that even ARBL won’t be able to lead the changes in the market for long, and neither outperform Exide on profitability on a sustainable basis.

In fact, despite the big difference in their respective revenues (ARBL is 50% of Exide’s sales), their margins are almost similar and return ratios also tend to move in tandem.

Overall, being in an oligopolistic market can turn out to be a huge positive for ARBL in the long term, but with the limitation that its only competitor Exide is not going to sit quietly.

Anyways, let’s now turn to how things are going specifically for ARBL as of now.

What Looks Good?
Here are a few factors that are working out fine for the company as of now…

1. Sales & profit growth: The duopoly nature of the market has benefited ARBL as it just has one competitor to fight, which it has done bravely over the past five years. This is given that, while Exide has grown its sales and profits at average annual rates of 16% and 34% respectively over the past five years, the growth for ARBL has stood at 22% and 61% (though on a lower base).

Rising earnings serve as a good catalyst for stock prices, which has been highly true in the case of ARBL. So it’s important to seek companies with strong, consistent, and expanding profits. Also, more important than the rate of growth is the consistency in such growth. While ARBL’s profit has grown in spikes over the past few years, I won’t consider it too volatile for discomfort.

As per some estimates, the Indian battery market is worth Rs 100 billion, with the automotive battery segment accounting for over 65% of the overall market value. While VRLA batteries have a 25-30% share, lead acid batteries dominate the market with a 70-75% share.

The market is growing at an average annual rate of around 15%, which I believe is going to provide enough growth opportunities to ARBL. The company has set its eyes on Rs 40 billion in sales by FY16, which seems quite achievable as it needs to grow at just 10% to achieve that.

Unless raw material prices don’t play spoilsport, I don’t see any issues in ARBL also growing its profits at a decent pace during this period.

2. Moat: While both ARBL and Exide have moats around them – brand recognition, stickiness in demand, distribution, and steady client relationships – ARBL has done better to grow its moat over the past few years.

This is clearly seen from the company’s steady gross and net margins (at 32% and 10% respectively in FY13), even in the face of rising cost of raw materials – which is Lead in this case.

Lead is the biggest raw material for battery companies, and forms around 85% of ARBL’s total operating costs…and 60% of sales. The rising prices of this commodity has been a tad negative for the company in the past as it has been unable to pass on the entire cost hike to customers given the slowdown in overall demand, and steady competition from Exide.

Exide is better placed on the raw material front. Lead forms less than 70% of its total operating costs and 45% of sales. This is given the company’s secures a part of its lead requirement from its captive smelters, which ultimately help it benefit on the cost front.

Anyways, the reason ARBL has not seen a major dent in its margins despite higher raw material prices is because of a steady decline in its sales and marketing costs, which stand at under 7% of sales currently, down from 11% a few years back. A declining sales and marketing as percentage of sales also gives an indication of expanding moat as the company is spending less to not just cover its turf but also grow its business steadily.

Finally, I did some scuttlebutt among my friends, a few car dealers, and on the Internet on ARBL vs Exide. The former (ARBL) seems to be winning hands-down in terms of user experience, and price versus value equation.

So the brand moat certainly seems to be working for ARBL, as seen from the faster growth in its sales volumes – 25% average annual growth in units sold during FY08 to FY11 – as compared to just 10% for Exide, though the latter’s volume sales are three times of the former.

3. Capital efficiency: ARBL’s deepening moat is also visible from its steady and marginally higher return on equity, which stood at 27% in FY13, up from less than 20% six years back. During the same period, Exide has seen its return on equity decline from 20% to 18%.

Overall, the capital allocation track record of ARBL has been good in the past, with steady and high return on equity, no acquisitions, and reasonable dividends (payout has averaged 15% over the last five years).

When assessing companies on these parameters, especially RoE, it pays to look at consistency. ARBL scores well on this test, plus its RoE is now better than the industry (Exide).

The low capital intensity of the battery industry has also helped ARBL in earning good returns in the past. The company, for instance, spent a total of Rs 460 crore as capital expenditure during the six year period of FY06 and FY12. Against this, it earned revenue of Rs 2,360 crore in FY12.

4. Balance sheet strength: ARBL, like Exide, also has a clean balance sheet with negligible debt. The entire capacity expansion over the past few years has been funded through cash generated internally, plus the company has also been left with steady positive free cash flows (at least over the last five years).

The batteries industry also has a small working capital cycle, which is seen in case of both ARBL and Exide. ARBL’s average receivable and inventory days have stood at 56 and 47 over the past five years (as compared to 30 and 75 respectively for Exide).

So, if you were to go by Warren Buffett’s rule of seeking out companies with conservative financing, ARBL will clear the test – on both fronts of clean balance sheet, and steady positive FCF.

What Can Go Wrong?
1. Overconfidence in its abilities: The biases that we individuals suffer are also imminent at group and corporate levels. This can especially be said of companies that have witnessed a recent spurt in growth and that too against the tide of slowdown in its consumer industries.

I see ARBL sailing in this boat, and it comes our clearly from the company’s FY12 annual report (the latest available), where the management writes – “We have created a business plan with stretch targets. We are confident that we will be able to catalyse growth and meet aggressive targets through stronger capabilities.”

While there’s no doubt that the company finds itself in a good position as of now as far as its capacities and future demand assumptions are concerned. But if the slowdown in automobile and telecom industries were to persist for some more time, it can create some problems for the ARBL.

We already saw some hints of that in the just concluded FY13, when margins came under some pressure as the company was not able to pass on the hike in Lead prices to consumers, owing to slowdown in demand plus increased competitive pressure from Exide.

2. High Lead prices can play spoilsport: A large part of ARBL’s sales and profit growth over the past few years have been driven by volumes – more batteries sold – than better prices.

So, between FY04 and FY11 for which data is available, while ARBL’s volume sales grew at 36% per annum, selling prices improved by just 3% per annum. This is despite that Lead prices rose by 18% per annum during the same period (FY04 to FY11).

So a clear-cut pricing power is not seen for the company, which is largely the case of competition from Exide, which sails in the same boat.

Anyways, a sharp rise in Lead prices can negatively impact ARBL’s profits and margins going forward, especially given that Lead forms around 80% of the company’s total operating costs and thus has a great bearing on margins.

What is more, the impact of higher Lead prices will be greater on ARBL than Exide, as the latter has its captive smelter capacities at its service that help it absorb some of the price hike.

What about the Management?
Given ARBL’s performance over the past few years, and especially the stability in its margins and return ratios, I am comfortable with the management’s execution capabilities and capital allocation skills.

However, there are two things worth mentioning about here…

  • ARBL’s Managing Director Mr. Jayadev Galla’s salary in FY12 was around Rs 17 crore, which was almost 10 times the salary earned by the MD of Exide, a company more than twice the size of ARBL. In fact, even the MDs of ARBL’s two big customers – Maruti Suzuki and Tata Motors – earn salary of Rs 3 crore and Rs 4 crore respectively, despite that these companies are much-much bigger than the former. This is a clear case of excessive compensation in ARBL.
  • Just to mention, the company’s management has a stake in Andhra Pradesh state politics, given that the MD’s mother is a minister in the state government. 🙂

Read through the Comments sections below for some more risks associated with ARBL, and a few corporate governance issues that cast doubts on the management.

Valuations?
I find it easy to value companies that have simple businesses and simple balance sheets.

Of course, there is a great probability that whatever valuations I work up won’t come out right (that’s the most interesting part about valuations :-)), but still I’ve tried to assess ARBL’s valuations.

I am not explaining how I arrive at these different valuations, as the calculations are all there in the excel sheet I shared earlier…just that I have done some slight modifications here and there in my valuation calculations to adjust for the sound business quality and competitive moat of ARBL.

So here are my valuations for ARBL based on different methods…

  • Average P/E Ratio Valuation – Rs 180
  • Earning Power Value – Rs 280
  • Discounted Cash Flow – Rs 320
  • Historical Earnings Growth – 325
  • Sustainable Earnings Growth – Rs 330

Some assumptions I have used for DCF calculations are:

  • Growth in FCF – 15% for first five years, and 10% for next five
  • Discount rate – 12%
  • Terminal growth rate – 2%

Based on this, my fair value estimates for the stock stand at Rs 250 to Rs 290.

On the face of it, ARBL looks fairly valued at this point in time, unless and until you want to be brave and buy the stock without any consideration for what Ben Graham said were the three most important words in investing – MARGIN OF SAFETY. That could be dangerous!

Anyways, just one more thing about ARBL’s valuations – the stock is currently trading at a price-to-earnings (P/E) multiple of 15x as compared to Exide’s 20x. In fact, ARBL has always traded at a discount to Exide largely on the back of the latter’s better-established presence in the industry.

However, if you were to consider the last few years’ P/E charts for both the companies, the discount is reducing. This is not just because Exide now commands a lower P/E multiple as compared to its past, but also because ARBL’s base P/E multiple has also risen to cover the gap.

Till ARBL does not do something really foolish, continues to be a simple business like it is now, and maintains a good growth record and clean balance sheet, I see the gap reducing even further. This could provide a fillip to the stock’s long-term returns, but only if you buy it after taking into account sufficient margin of safety.

You see, sensible investing is always about using “folly and discipline” – the discipline to identify excellent businesses, and wait for the folly of the market to drive down the value of these businesses to attractive levels.

You will have little trouble understanding this philosophy. However, its successful implementation is dependent upon your dedication to learn and follow the principles, and apply them to pick stocks successfully.

Never forget that, as an investor, it’s important to focus on decisions and not outcomes.

When I combine ARBL’s business quality with its valuations, I get a good business at fair valuations, which leads me to wait for a lower price before I can own the stock.

You don’t have to agree! 🙂

In the Comments section below, let the tribe know of your own analysis of ARBL…and also share your feedback, if any, on my report.



Before I close, here’s some information about the upcoming StockTalk reports.

I have received an amazing response from tribesmen for the proposal to collaborate to write StockTalk.

Based on the responses I have received and with a view to cover companies from diverse sectors, here is the list of upcoming StockTalk coverage so that you are prepared with your own analysis to participate in the discussion. This covers the next six months’ coverage…


If your name is in the list, please send me an email at vishal[at]safalniveshak.com, so that I can contact you directly to discuss the report format, deliveries etc.

If you chose to write a StockTalk but don’t find your name in the list above, please don’t feel bad as I will include you in the next list after this six months period is over.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.

Comments

  1. Sridhar says:

    Amar Raja is an interesting pick. The business also looks simple – no multiple subsidiaries, divisions or complexities.
    I’m presenting some views – positive/negative/neutral

    1) Net Profit Margins in last 5 years (07-12) were in the 6-12% range. However, ROE and ROCE were in 20-30% range. So its a case where low/moderate margins can be mitigated by huge volumes and demand.
    2) But on the Flip Side NPM before 2007 margins were less, and ROE and ROCE were also less. Probably the cycle of business might turn.
    3) The Auto industry has been seeing some slowdown which will impact – again one can argue that battery is a recurring item and people may replace it after 3-4 years or so.
    4) Solar industry: If there is a huge impetus to this sector, the demand may increase.
    5) There are several fragment players such as Luminious and other players in areas like inverters, power, electric accessories who may enter this space.
    I read about this. Probably someone from this industry could elaborate on this. If this happens the strong Moat, oligopoly could get challenged.
    For instance in printer cartridges which was the cash cow for printer companies, entry of new players has been a threat though barrier to entry exists.
    6) Recharging – People from electric field will know that now there are ways in which you can recharge or revitalize batteries and extend its life.
    This can pose a threat to recurring sales. Again I’m taking the example of printers, where cartridge refilling has been an alternative – though it has pros and cons.
    But most people will not resort to this or may want to buy a new one for peace of mind/smooth running of vehicle or other equipment.
    7) Sectors where it is used – power, telecom, automobile………… we already see slowdown in power and automobile and it will have an impact. Since most of these industries
    are in utilities or commodities space with poor pricing power, the same effect can rub on Amaraja if they start bargaining or turning to new suppliers.

    • Thanks for sharing your observations on the business, Sridhar! Indeed, the next few years will be a test for ARBL especially if its consumer industries were to remain mired under slowdown. Regards.

  2. Nishanth says:

    Vishal,

    I have 2 comments

    1)Very excessive management compensation
    2) Hyderabad based company

    So that rules out investing in this company 🙂

    • Hyderabadi says:

      VST industries is from Hyderabad too. I am sitting on a lot of capital gains and more than your FD + tax free dividend income since 2009. Your conclusions are short sighted and shallow.

      • Nishanth says:

        Hyderabadi,

        Agreed. VST Industries has been a fanatastic stock for its shareholders. I didn’t mean to imply any regional bias against Hyderabad based companies, but my experience is that too many companies coming from that region has been implicated in corporate scandals and misgovernance issues (Satyam,Bartronics,MIC Electronics to name a few) . Of course there has been good companies as well,but if you may care to examine , the fact remains far greater companies have caused greater grief to their shareholders than have made them happy (as in your example). Of course , we can cherry pick companies from Delhi as well in the list :).

        Now, if you disagree with the statements I have made below , lets just say you have your views and I have mine:). Let’s not have a disagreement that can disintegrate into a regional fight :). I have the utmost respect for Hyderabadi food as well 😀

    • Hey Nishanth, the point on compensation is taken. But the point on “Hyderabad, so avoid” is first conclusion bias. 🙂

      Though, purely based on history of so many Hyderabad companies, it’s an important checklist point…but it pays to delve into each case separately. Regards.

      • Nishanth says:

        Vishal,

        Point taken. If I had followed the first conclusion bias , I would have avoided VST Industries as well. But again , I would be doubly careful of these companies.
        As you said , it is essential to delve into each case separately.

        • Indeed Nishanth! Anyways, your thoughts on it being a company from Hyderabad and thus being careful of, has been validated by more comments that have come in…that have highlighted some corporate governance issues. 🙂

  3. Hi vishal,
    Very elaborate and insightful analysis. The part which I liked most is WHAT CAN GO WRONG. Over confidence of management and high compensation are 2 major factors that go against this company. Even when i analysed this company couple of years back, the so to say over confidence turned me off. Till the time company grows, management claims are music to ears, but in bad times true test happens. I think ARBL is yet to go through that bad phase to prove its superiority. I might be expecting too much from it.

    Regards

  4. Great analysis, Vishal. I loved that you explained about duopoly and oligopoly as a key takeaway from this stocktalk. I’ve done a brief study of the latest AR for the company, and based on my perspective, here’re the concerns:

    1. I recently had to replace my home inverter battery, and the study of market indicated that Exide batteries are slightly cheaper, at least for the industrial segment. This may put further pricing pressure for ARBL, apart from the rising costs due to lead.

    2. The batteries market has grown fast in the past, but could the “refurbishing” play a spoiler on further growth. Consider this – batteries have to be replaced in 3 / 4 years, which means that the sales will be steady. But if automotive industry doesn’t continue to grow rapidly as it has in last 5 years, would it not mean that batteries only get replaced – but the volume growth subsides. I’m assuming that “re-furbishing” is a underground industry (I’m not sure, need to validate from industry experts), and this helps recycle the raw material (lead, acid, plastic container, etc), but in any case, it could mean slower volume growth than ever before, unless we see good growth in automotive (nearly everyone today has a home inverter today) and telecom, both of which are quite unlikely unless India gets back to a lower inflation future.

    3. Market expectation – people have seen ARBL stock fly like anything, and I’m sure market is expecting the same growth. If the growth stagnates for a few quarters to come, ARBL stock price can get beaten down, creating opportunity to buy at lower prices (if you still believe that business is good in long term). Also, the stock has become pretty volatile (I’ve seen it move between Rs 225 – Rs 280 / 300 several times in last few months)

    4. I’ve not done this analysis, but given the growth assumptions, how long will it take for ARBL to capture 50% market share? I ask this since thereafter, ARBL will be dependent on industry growth (external, not in control of the company) alone, and they’ll have to work “hard” to maintain their market share since EXIDE will certainly fight back. Then, the business may not remain so attractive?

    5. Finally, I also found MD&A to be too optimistic and over-confident, and yes, management compensation is too high, and I’ve a gut feeling that the management is not so “elegant”, and that’s a BIG risk to minority shareholders in my opinion.

    Overall, in my opinion, I’d consider this as a 2-4 years play, and may not want to hold after ARBL’s market valuations approach Exide’s, and I’d not buy large quantities above Rs 200 (though given that business is quite good today, I’d not mind taking small positions below Rs 240ish). However, after we answer the following questions:

    a. When will ARBL and Exide’s market share become equal (since this involves projection, there’s large chance of error), since this will determine my investment horizon in this stock.

    b. Has battery re-furbishing worked against volume growth in the past (in US/Europe, etc)? Can we quantify this effect, which may significantly lower the future growth rate assumption?

    c. Any instances of questionable management character, outside the business? Is ARBL business benefiting from political links, which if exposed in the future can severely impact the stock price?

    d. New innovation – I’ve read and heard quite some significant technology enhancement in battery technology and research, mainly driven by handheld device needs, but if such a breakthrough technology goes commercial (it can also enter automotive quickly since it’ll help reduce battery weight that adds to vehicle efficiency), it can be disruptive to both Exide and ARBL (I doubt if they’re involved in any form of breakthrough research…). What if this breakthrough happens outside India, and auto companies find it advantageous to import the batteries (not for cost, but if it gives then a superb fuel efficiency advantage), it may kill the business for both these “pure manufacturing companies”

    On point d) I find it as biggest threat to “simple businesses”, especially those who deal with some form of “high tech” manufacturing, which includes ARBLs, Indian auto manufacturers and generic drug makers – innovation is the biggest threat to their business model, and the new reality of knowledge world. I found the following two interesting articles, and I’d be very wary of these developments for the Indian battery manufacturers, and I sincerely wished they tied up and funded some good research on battery technology in our academic institutions (if someone knows they’re involving in research, pls post here)

    See this excerpt, and I know how important safety is for automotive companies as we design next generation automotive microcontroller, and soon it’ll be important in India too (no, cars get recalled for safety concerns in India too, read this): “Their aim is to build a battery strong enough to power a wider range of vehicles, something they think the current cutting-edge technology — lithium ion — can’t do cheaply, particularly given recent safety scares.”

    And read this, a new technology on automotive batteries.

    • Rajesh Sankar says:

      I agree with Sunny for point #d, please read the following link about electric cars, The US has pledged US$2.4 billion in federal grants for electric cars and batteries. Wikipedia Link on Electric cars.

    • Agree to your viewpoints, Sunny….and thanks for the new perspectives!

      Yeah, future growth won’t be easy for ARBL, especially given tightening competition from Exide combined with the slowdown in its consumer industries. While its promoter Johnson Controls does provides it a tech edge, obsolescence remains a key risk. Regards.

  5. Ganesh R says:

    There was a split approximately a year ago. After that, the stock has moved up quite a bit. Does this in any way change your valuation outputs Vishal ?

  6. Thanks Vishal. An excellent post cover nicely covering nuances of an Oligopoly market.

    I just have one more point to add – based on my personal experience and to elaborate a bit on purchase decision of batteries since I recently went through one. I purchased a battery for the first time (not Amaron) and then purchased ARBL stock.

    Dealer tie-ups and incentives in my view are critical success factors. Six months back when I went to replace the car battery, the shop was covered with posters of Amaron. The seller had 50 – 60% inventory of Amaron, ~20-30% of Exide, few Tatas and 4-5 Bosch on display.

    There was a clear “push” from the dealer towards Amaron. A new / novice buyer like me will invaribly ask which battery will last the longest and these guys will push the product which gives them the best margin, not necessarily the best product, in my view.

    These auto shops are also aware of marketing “pull” which Amaron has created and thus are happy to have a larger inventory of Amaron. Since most car owners and drivers dont necessarily have the best techincal know-how about this, in majority of cases will actually let the dealer make the purchase decision for them (though they still think that they made the decision).

    I would think of Paints or Engine Oils as some other classic examples where the purchaser doesnt have the complete know how of the product and relies on the brand recall (pull) and the distributor/seller suggestion (push). And we can see how companies such as Asian Paints and Castrol have managed to attain significant leadership by managing both marketing and distribution. And unlike other consumer durables or autos, these arent exactly marketed by way of mouth – I mean, we will hardly discuss an engine oil or a paint purchase with friends. We will do it for TVs, ACs and what not.

    While I was doing some Q&A and getting my battery replaced, there were several other purchasers which came in – some end users and some drivers. Most of them werent exactly buying the battery for the first time like me, seem to knew the auto parts dealer, walked in said, “Yaar nayi battery daal de”. Not many questions asked. And I saw more Amaron being sold.

    To wrap up my experience, after asking several questions, I bought a Bosch. It was ready to provide a much longer tenor warranty, though at a 15 -20 % premium (that’s what I vaguely recollect). Came home, researched Bosch, Amaron and Exide and then bought ARBL.

    Regards,
    Ashish

  7. Hi,

    Nice company to start with. Have been watching Amaraja’s rise for the past 10 years since it was part of my Dad’s portfolio. Leaving alone the bull run in the stock, let me play the Devil’s advocate here and come up with some negatives for ARBL. BTW, the company is not based in Hyderabad and is located in Tirupathi ( my hometown ) , please don’t put it in the same league of DC or Satyam though generalizing that way is really absurd. Ok, now coming to the negatives:

    1) Yes , management focus. As mentioned in the post, the MD is the son of a State minister and has been trying to get a party ticket to contest as an MP in the coming elections. So there goes the focus on the company! Also, I don’t see any professionals working in the top management. I can understand family members managing a small company , but managing a business of the size of ARBL would definitely need the help of a few professionals.

    3) The market is not a duoploy anymore. Each market has several other players who have their own strengths. Microtek is a strong one in inverters while Mahindra is a recent entrant, not to forget Luminous. Similarly for automobiles, there are smaller players like Amco etc who offer cheaper products with the same warranty promises in the replacement market.

    2) Even I was pleasantly surprised with the market shares reported in last year’s AR. But the situation on the ground is completely different. I had the opportunity to explore three battery markets over the past 1 year for my personal use( 2 wheeler battery, Computer UPS and Invertors). Coming to the 2 wheeler one, the showroom servicemen discouraged me from going for an Amaron battery saying that the user experience has been negative for the same. Amaron does not even figure in the world of invertors with players like Luminous, Microtek , Exide leading the charge. I get the feeling that somehow the company is only concentrating on B2B markets like telecom batteries etc at the cost of the retail markets like invertors, 4 wheelers and 2 wheelers. Just walk into any auto-dealer and check the company supplied battery. Its still Exide everywhere. Don’t know why ARBL is not able to grab a few contracts with auto manufacturers. Even the Ad spend is miniscule. So if the customers don’t know abt the brand and the dealers/servicemen are averse to selling the brand, then how are going to grow?

    3) A minor irritant but a major one from a corp governance point of view.The annual AGM of the company is held in the factory premises of the company on the outskirts of Tirupathi( which even I find difficult to access). This is ridiculous. When your administrative office can be in Hyderabad, why should you hold ur AGM in ur factory ( not even in a meeting hall in Tirupathi town), unless you want to shun uncomfortable questions from investors,

    • Nishanth says:

      Kumar,

      Interesting points. I believe Vishal was trying to tell people to be doubly careful of Hyderabad based companies ( even though this is based out of Tirupathi , as from your comments) because a lot of companies were in the limelight for such reasons. Now , when such a highlighting is present in the news , automatically people became wary of investing in companies with such a background. Now is such a bias valid ? Not sure. But should people be careful ? Very much ,as I remember once upon a time , Satyam and Bartronics were the darlings of the bourses. Now is this limited to Hyderabad based companies ? Of course not , crooks and charlatans exist in every community , region and religion and are only limited by their ingenuity and their gullibility.

      Now was I guilty of “jumping to conclusions” ? Yes, I was. I have heard far too many stories not to be wary . But I was wrong in not investigating further and drawing a hasty conclusion.But after seeing your comments , my view only got strengthened.

      I always look for reasons NOT to invest in a company 🙂

    • Thanks for sharing the bird’s eye view, Kumar! 🙂

      The top guy’s salary plus connections in politics create a big red flag. Now, what you have mentioned about its AGM raises the antennae even higher! Thanks for sharing your perspectives. Regards.

  8. Krishna says:

    Hi Vishal…. Superb Analysis….. & equally great comments from other members… I was always wondering whats the right way of valuing a company, your this analysis got me rid of that confusion. So many thanks to that!!

    Now about the concern raised by Sunny about some major technological breakthrough driving a blowing change to the company. Well if the company is focussed it will not miss the change and brace itself very well in advance. But given the company’s MD interested in politics and using company’s funds(higher compensation) to finance his this venture we are on very shaky grounds. Also the fact that there are no professionals in the management of the company is a very big negative.

    Also markets high expectations from the script is not very positive. Especially on reports that Europe car sales are going down. How long do you think that it will take the trend to catch up in India? Or are we counting on growth in Tier-II & Tier-III cities??? Coz I dont really see a lot of growth coming from Tier-I cities due to high levels of traffic congestion and people shifting to public modes of transport like metros.

    • Thanks Krishna! Well, I see a large part of growth coming from the replacement market where Exide is a major player and ARBL is only now getting aggressive. It would take a huge effort on the part of the company to shake things up here, especially given Exide’s highly localized presence (I can see the Exide brand in even the smallest or towns in India, not Amaron). Combine with this, the stock’s fair valuations asks for caution.

      Thanks again for sharing your feedback! Regards.

  9. Vishal,

    With regards to moat, what would the market look like if a battery manufacturer from China like BYD enters into the market. Also, the moat looks fragile even though its oligopoly at this point. If Amara Raja could come with good product and with eye catching marketing campaign and gain this big a market share from Exide, what would stop other big battery companies with spending power/cheaper capital to do it? I think that is one of the risk that we need to consider in terms of downside in my opinion. If we purely go by Porter’s analysis, it cannot control raw material prices, it can neither pass the cost to customer, it does not produce a good that is not replaceable by some substitute or neither is its product protected by some license or IP. All it has is some mindshare but it does not translate into protecting its margins.

    Regards
    Ravi

    • Agree to your viewpoints, Ravi! Exide isn’t going to sit quietly and let ARBL make it up to it. Competition from China won’t be such a big issue given that this industry works on OEM relationships, which are hard to crack. But yes, in light of higher lead prices, protecting margins would be an issue for ARBL. Regards.

  10. i am from hyderabad, there are several good companies like kaveri seeds, vst industries, dr reddys lab etc

    galla jaydev has tried to contest from tirupati assemby seat vacated by chiranjeevi. his mother is in congress govt. its unlikely congress comes back to power 3rd time in a row. i am not comfortable with mixing business and politics. i will stay away from such companies. look at dlf, jp ass, india cements…

  11. Deepen V says:

    Hi Vishal,

    Good analysis and definitely gives a great perspective studying a company.

    I have a sincere request. 1 Analysis per Week seems very less when there are so many companies to study. I think you should raise the limit to atleast 2 Cos per Week i.e. One on Sunday and one on Thursday. This will keep the balance.

    Just my suggestion 🙂

  12. Vishal,

    Corporate Governance is a serious issue in this firm.

    Its worth highlighting the Price Rigging episode in the past involving ARBL management. That cant be brushed under the carpet.
    (Link)

    Management’s political linkage is a tricky issue as well – e.g Aurobindo Pharma

    Management Compensation – already highlighted in your discussion

    Thanks,
    Ashis

  13. I think few points have got less emphasis in this story and subsequent discussion .

    1) Johnson Controls (26% stake).- Availability of tech (shield from major tech shift), control on business (second eye)
    2) Solution provider – not just battery provider but Amara raja is providing complete solution
    “In the industrial battery business, our alliance with Bharti Airtel generated large exports to Africa, Sri Lanka and Bangladesh. Besides, our transformation from a product vendor to a solution provider generated good business in the telecom space. Strengthening penetration, enhanced recognition of product performance in BFSI, government and corporate circles delivered sizable volumes for our UPS batteries – we grew faster than the industry.”
    3) Export – Can they expend this business outside the countries like Africa, Sri Lanka and Bangladesh?

    ————————- Other points
    4) Competition – Any competition will not throw them out over night. It takes time to build franchises, win customer and reach to scale. Not to forget telecom market is from last many years still they ere managed to do well. Panasonic, tata, and other big player already there in this market.
    5) Refurbished battery- Is refurbished product as good as new? if not Refurbished product will compete in non-organised market, not with organised market.
    6) Price rigging – has there been any other report after this report in 2001? in 2001 their market Cap must be 1/30 of current. between jan 2010- Dec 2011 stock gave only 20% return.

    • All valid points, Bhupesh! Just that a second level thinking is required in this case. If most people are bullish on the buisnesss (as stock valuations suggest, and as the management’s over-optimism also indicates), we must answer what could go wrong. So yes, while I agree to the positives you have mentioned, there’s no doubt that this management requires an added level of caution. Regards.

      • I am invested in this company from last 4-5 years, so have gained on it. But it was not easy, every time a Hyd company ditched investor (including me) I started suspecting it. Between Jan 2010 and Dec 2012 stock’ performance was not that good. There has been been PE expansion.

        The things which kept me invested in this company .. 1) regular dividend 2) low debt 3) good industrial clientele. 4) General feedback on business from my friend who has battery manufacturing unit in addition to points mentioned.above in my comments.

        If after last one year’ spectacular run it is still at low end of your fair value range. One can still be cautious and remain invested.

        Probably it is time for to attend AGM to ask some tough question as some comments suggest.

  14. As always, good analysis Vishal. Thank you so much for publishing the report.

    I’d like to add one point not discussed so far. I’ve a big discomfort with this company on corporate governance part. They have a lot of ~300Cr of related party transactions with the promoter owned company. It gives a lot of discomfort to me to stay away from the stock. Big surprise is that JC Control’s presence could not stop this dirty thing going on inside the company.

    This company does not clear my filter of management checklist and hence a pass. Look forward to next report.

    Best
    Rajat

  15. May I suggest editing the original post with the points discussed in comments… will make a good comprehensive read….

  16. Thank you for the analysis and other tribesmen for such enriching discussions.
    Corporate governance is something that can be the weapon of mass destruction.
    So that is something one must watch out for.

  17. Srikant says:

    Thanks for the in depth analysis, Vishal. Two questions-

    Johnsons Control won a major contract with Wal Mart (resulting in bankrupcy of Exide technologies). Can this bring more business to Amara Raja?

    Would the Telengana issue have impact on ARBL?

    Srikant

  18. see i have investd in arl in sep 2000 or much before asssuming aprice of rs 90 in sep 2000 and co has issued bonus shares of 1 share for evry 2 share and split into re 1 the total holding will be 1500 shares of re 1 each for evry 100 share held in sep 2000 so co has given appreciation of more than 33 percent apart from div which has apolicy of some 20 or 25 percent .again johnson control not ordinary co like in india we have and in fact in the rigging case i have filed the case against sebi for the non application of mind by not delivering the shares purchased and not giving the amount for the inv who sold shares .in fact sebi as aearly as 2000 itself has devated form the path for which it was formed .little said the beetr about sebi .so dont blame the co for the non application of mind on the part of sebi which acted in haste .

  19. You don’t think exide is a value investing now as amaraja is a growth fund.

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