Amara Raja Batteries: Why analysts predict 20-40% upside in stock despite challenges

The brokerage’s analysts said replacement demand in the auto vertical will be Amara Raja Batteries’ key growth driver in the medium term. (Photo by Kindel Media/Pexels)

Amara Raja Batteries stands at a turning point.

It is the leader in the lead-acid battery market, with an almost 40 percent share of the organised segment.

Lead-acid batteries have traditionally been used to store power for automotive and industrial uses. Amara Raja gets its revenue from these two segments, mainly from auto over most of the past decade. In FY22, 73 percent of its topline came from the automotive business.

Also read: These are the stocks that FIIs loved in the December quarter

Now, as automobiles move to lithium-ion batteries that pack more energy per unit mass and are more efficient, Amara Raja is making the shift too. In Q3 of FY23, lithium battery packs started contributing to the company’s topline and made up 3 percent of revenue. In December, the company said it would set up a lithium-cell gigafactory in Telangana, spending Rs 9,500 crore over 10 years.

Besides this structural shift, the company faces near-term challenges. Its earnings are highly dependent on lead, which had a highly volatile year in 2022, and three of its production units received closure notices from the Andhra Pradesh Pollution Control Board.

Despite these challenges, some brokerages expect the Amara Raja stock to appreciate by 20-40 percent. What are they counting on?

Volume advantage

Analysts at Anand Rathi expect the share to appreciate as volumes and margins improve. The brokerage maintained its ‘buy’ call at a target price of Rs 819 (14x FY25e), which is more than 42 percent higher than the current price of about Rs 573.8.

In the December quarter, the company’s revenue grew 12 percent YoY to Rs 2,637 crore and volumes increased 8-9 percent on strong replacement demand in the automotive segment, and healthy demand in the telecom and UPS segments helping the industrials vertical.

“Within automotive, 4W OEMs and replacements grew ~5% despite a high base last year, the 2W aftermarket grew ~15% y/y, while OEMs were weak. Exports also grew strong, said management. The industrials segment grew a strong ~20% y/y on one-off demand from the launch of 5G towers and better UPS offtake. We continue to expect strong volume growth in subsequent quarters as OEM offtake picks up in the near term,” the Anand Rathi analysts wrote.

Sharekhan, which has a ‘buy’ call on the stock with a target price of Rs 696, noted that demand is picking up in the automotive and industrial verticals.

“Automotive demand is expected to see strong recovery in the two-wheeler (2W) and four-wheeler (4W) segments, aided by pent-up demand and increased need for personal mobility transport amid the COVID-19 pandemic. The industrial segment may take a little more time to recover compared to automotive, except the telecom segment,” Sharekhan analysts wrote.

New-age business

The brokerage’s analysts said replacement demand in the auto vertical will be the company’s key growth driver in the medium term. In the longer term, they said this healthy demand and its brand equity and extensive distribution network can be leveraged to power strong growth in the battery industry.

Anand Rathi’s analysts said that by starting supply to the electric three-wheeler segment, the company will grow well in the near term and it is a good signal for its long-term growth. They expect the lithium-ion gigafactory to be ready in the next 16 to 18 months.

Amara Raja has spun off its new-energy business, including its lithium battery pack manufacturing and R&D pilot plant that also makes Li-ion cells, into a wholly owned subsidiary Amara Raja Advance Cell Technologies through a slump sale. Sharekhan’s analysts pointed out that this will help the company to better focus on the new-age business and unlock its value. The turnover of the new-age business was Rs 65.97 crore in FY22.

Also read: Which are the stocks that have the potential to ride the EV theme?

Margin expansion

The brokerage’s analysts noted the company’s healthy margin expansion in the December quarter.

“The correction in raw-material cost (lead) has benefitted the company in Q3FY2023 and, hence, its gross margin has expanded by 360 bps y-o-y and 290 bps q-o-q to 33.4%. With favourable gross margin expansion, EBIDTA margin expanded by 300 bps y-o-y and 170 bps q-o-q to 15%. This was the second consecutive quarter when ARBL has registered sequential improvement in its EBIDTA margin and registered the highest EBIDTA margin in the past seven quarters,” they wrote.

While margin improvement may weaken in the March quarter, with lead prices inching upwards (5 percent), analysts said this is not a long-term concern. Anand Rathi’s analysts expect the EBITDA margin, which was 11.8 percent and 13.2 percent in FY22 and FY23, respectively, to rise to 13.6 percent in FY24 and FY25 with OEM demand picking up.

Last year, the company demerged a vertical – plastic components for the battery business – from its subsidiary Mangal Industries and merged it with Amara Raja. This merger, analysts said, will be EPS accretive from the very first year. Sharekhan’s analysts said the merger will lead to margin improvement and lead to annual recurring post-tax synergies.