Upgrading to Buy on likely expansion of margin: We are upgrading Exide Industries to Buy from U/P (under-perform), as we expect it to benefit from an imminent increase in pricing power in automotive batteries. We have raised our price objective by 31% to R160, led by (i) EPS upgrade for FY14/FY15e (estimates) by 8/9% as a price hike should boost margin, (ii) likely re-rating of the battery unit to PE (price-to-earnings ratio) of 17x FY14e, equivalent to its historical average, instead of 14x (times) trough P/E as assumed earlier, & (iii) rise in insurance unit value from R15 to R20/share owing to a recent increase in stake from 50% to 100%.
Immediate triggers are price hike and incentive reduction: We expect Exide to be able to hike prices in its branded battery as well as OEM (original equipment manufacturer) businesses and also cut back on dealer incentives. Key drivers of this price hike are (i) capacity constraint at key competitor Amara Raja, (ii) rise in the cost of lead---key raw material, and (iii) reduced thrust on market share gain given that it has already regained market share to the minimum desired level of 32%.
Decline in competitive intensive to boost pricing power: Key competitor Amara Raja is operating at over 90% capacity now and is unlikely to see significant addition to its capacity before the end of 2013. Amara Raja has recently stated its intention to hike prices owing to the rise in lead prices. This will be a continuation of the trend of around 4% price hike effected by Amara Raja in Dec 2012, following similar price hikes by Exide earlier in Oct 2012.
Exide is better placed to deal with rise in cost of lead: Based on our analysis, 1% rise in lead cost, the key raw material can impact Exides FY14e EPS (earnings per share) by 4%. However, unlike competition, Exide sources 50% of lead from in-house smelter. We therefore expect to Exide to gain competitive advantage in the scenario of rising lead price.
Upgrading EPS by 9% on stronger margin: We have raised our EPS estimates for FY14/FY15e by 8%/9% driven by a 114bp/113bp (basis point) increase in the margin to 13.9% and 14.3%, respectively. We now expect EPS to grow 34% in FY14e and 22% in FY15e, respectively. We have assumed the following to drive margin expansion: (i) Price hike of 6-7% for OEMs and 5-6% in replacement batteries owing to rise in pricing power. (ii) Lack of wage inflation in FY14e and FY15e as the company recently concluded a new wage policy that will last for the next three years. (iii) Capacity utilisation of the automotive battery segment likely to rise to 90% in FY14e /FY15e compared to 80% in FY13e.
Insurance business valued close to book value: Exide Industries recently entered into an agreement to buy out its partners and raise its stake in ING Vysya Life Insurance from 50% to 100% for R5.5 billion. Following, cumulative investment by Exide in ING Vysya Life will rise to R12.94 billion (R15/share of Exide). We value the life insurance business at R20/share by using a 7x NBAP FY14e + 1x FY13e EV (enterprise value). NBAP stands for new business accrued profit.
BofA Merrill Lynch