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Exide Industries - High valuation

This market leader has sound fundamentals but valuation has run up

Exide Industries Ltd (EXL) is India’s leading battery manufacturer. It has around 60-65 per cent market share in the auto battery segment and 40-45 per cent market share in the industrial battery segment.

Strengths
Captive sourcing of lead: Exide has acquired lead smelters which are able to recycle used lead, thereby reducing its dependence on imported lead. In FY10 these smelters supplied 50 per cent of its lead requirements (plans to increase this to 70 per cent by 2012). Lead from captive source is 10-15 per cent cheaper than imported lead. Thus the company has, to some extent, protected itself against the danger of a sudden spike in the price of lead.
Pricing power: The company has price escalation clauses built into its supply agreements with the OEM segment and the industrial segment. This helps it protect its margins against an escalation in the price of lead. (This facility, however, is not available in the replacement segment.)

Weaknesses
Capacity constraint: In recent quarters the company has witnessed a steep increase in demand for both car and two-wheeler batteries, which it has been unable to meet. This has affected revenue growth. Most of its existing supplies have been directed towards the OEM segment at the cost of the replacement segment. Margins in the latter segment are higher. This affected its overall margin in Q2FY11.
Weak demand from telecom: Both volume demand and price realisation from telecom continue to be subdued. However, Exide is less dependent on this segment than rival Amara Raja.
Higher lead prices: While Exide is better protected against the impact of higher lead prices, it is not entirely immune. In Q2FY11, its EBITDA margin declined 421 bps y-o-y owing to a 447 bps increase in raw-material costs (as a percentage of sales).

Growth initiatives
Capacity expansion: It is commissioning a new plant at Ahmednagar for bike batteries and setting up additional production lines at Shamnagar and Haldia for four-wheeler batteries. These expansion plans will entail a capital expenditure of Rs 400 crore and will enhance its two-wheeler battery capacity 60 per cent and four-wheeler battery capacity 28 per cent.
Analysts at Angel Broking expect Exide to post robust volume growth of 15.7 per cent in the auto segment and 17.2 is per cent in the industrial segment between FY10 and FY12.
Capacity expansion is also expected to result in an improvement in margins (because the company will be able to cater to the replacement segment where margins are higher).

Opportunities
Robust demand: The battery market in India is expected to grow at a rapid pace. Exide is also expected to clock 20-plus percent growth in both auto and industrial segment over the next two years.
Due to its better control over costs and its pricing power, analysts expect its bottomline to grow at around 19-20 per cent.

Valuation
The stock is trading at a PE of 24.07. This is higher than its five-year median PE of 21.31. Over the last five years its EPS has grown at a CAGR of 41.7 per cent. This gives it a price-earnings to growth ratio (PEG) of 0.58. In view of the recent run-up in its valuation, accumulate the stock on dips.