March 16, 2022

Consumer sector: Raw material inflation may weigh on profit margins

• The sharp rise in commodity prices (led by Russia-Ukraine conflict) would weigh on profitability of most consumer companies in the near term. Further, it would impact consumption that was already showing signs of weakness (especially rural demand).
• At current RM prices, several consumer companies would need to implement incremental price increase of 4- 12% at portfolio level in addition to a similar price increase taken in CY2021. This may further impact the already demand conditions, especially in the rural India.
• The magnitude of demand destruction due to inflation would vary across categories. The impact may be most for HUL and paints companies.
• Asian Paint’s may need a double-digit price hike and greater formulation efficiencies to maintain absolute gross profit on a per ltr basis. Challengers in the paints business, (Indigo, Shalimar, JSW and Grasim) will find the going difficult in this environment and maintaining margins and gaining market share would be a challenge.
• Inflation in glass bottles/cans and wheat/barley would impact profitability of liquor businesses.
• At a broad level, we expect weak rural demand and incremental inflationary pressure to weigh on volume growth and earnings growth in FY23. We now expect low single digit growth for most FMCG companies.
• Margin recovery expectations have been pushed back by a quarter or two.

However, on a medium-term basis, we expect recovery in margins as RM prices eventually normalize (as seen in the past cycles). Titan is relatively better placed within the consumer discretionary sector, as it does not have RM-related headwinds. We continue to like Godrej Consumer as the stock price has corrected appreciably in the past three months.

Battery Manufacturers: Reliance continues to fill the gap; buys expertise in Lithium Phosphate cell manufacturing

Reliance Industries Ltd.’s subsidiary has agreed to acquire the assets of battery maker Lithium Werks BV as they have been buying new energy assets to fill all the gaps. Reliance New Energy, a fully owned arm of RIL, will pay $61 mn to acquire the assets of Lithium Werks that provides cobalt-free and high-performance lithium iron phosphate batteries. The assets include an annual production capacity of nearly 200 MWh including coating, cell and custom module manufacturing capability, 219 patents, including exclusive rights to superior LFP nano-technology, cell design, proprietary carbo-thermal reduction manufacturing method and, several next-generation electroactive materials.
This deal is a part of Ambani’s commitment to invest $10 bn in sustainable energy initiatives over three years. Earlier, it had acquired Ambri  – a liquid metal battery and Farradion – a Sodium ion battery.  These acquisitions are likely to enable them to leverage the experience of senior management team, together with the technology and know-how of the acquired entities.
Batteries are expected to play a very significant role in energy transition. While various chemistry are at play, Lithium ion remains the fulcrum on which the edifice rests. In Lithium iron batteries, Cathode active material is the key which constitutes 35-40% of total battery costs. While energy density is of paramount importance in vehicles, it is less important in energy storage markets.
Around ten companies including Reliance have applied for Advanced Chemistry cell PLI. Reliance is looking to buy all the new technology – betting on all the emerging new technology. However, batteries remain the key and we understand that factory doesn’t get obsolete even if CAM changes. The objective of the battery manufacturers is to replace cobalt, the costliest material and add Manganese and Aluminium in Cathode which makes it safer and cheaper. Also note that Exide, M&M and L&T have also participated in PLI. Lithium Phosphate is cheap and safe and low lifecycle but comes at the expense of lower specific energy density. There is a trade off in battery chemistry – energy, life and cost. Lithium phosphate is largely chosen for the cheaper electric cars. It’s also a favourite chemistry for Tesla. All set for interesting times for battery manufacturing in India.

Persistent Systems: Acquired New Jersey based MediaAgility

Persistent has announced its acquisition of New Jersey based MediaAgility, which is a global cloud transformation services provider with deep expertise building scalable, cloud-based solutions as a Google Cloud Premier Partner. The Company provides cloud-native application development and modernization, analytics and AI, cloud engineering, migrations, and managed services to its’ 35+ enterprise service clients across the globe. MediaAgility has been positioned by Gartner® as a Niche Player in the 2021 Magic QuadrantTM for Public Cloud IT Transformation Services. The company has 500 employees.
With the increased demand for Google Cloud expertise, this acquisition will expand Persistent’s ability to execute cloud-based digital transformation journeys for our global clients. It will also expand footprint within 35+ new enterprise service clients and strengthen talent with 220+ Google Cloud certified architects and cloud engineers in US, Mexico, UK, and India. Persistent’s strategic aim is to develop an all-encompassing set of cloud capabilities for our clients.
In February, Persistent Systems had announced acquisition of Azure cloud practice specialist Data Glove Inc. (U.S) for a total consideration of USD 90.5 Mn, (incl. earnouts and retention/performance based payment). Data Glove Inc. (Rev USD 48.96 Mn), specializes in providing services across Microsoft Product Suite viz. Azure-based digital transformation. Through its acquisitions, Persistent has shown clear intent to grow its cloud-based digital transformation practice. Earnings growth is expected to be strong at 20% CAGR over FY22-24. Due to impeccable management quality and execution coupled with its strong positioning in fast growing cloud-based solutions business, the stock enjoys a premium valuation (PE of 39x FY23 est). We remain positive on Persistent but would rather wait for market corrections to buy the stock.

Ramkrishna Forgings: Won an order worth Rs 750 mn from  India’s largest OEM

Ramkrishna Forgings Limited has won an order worth Rs 750 Million per annum from India’s largest OEM in the MHCV segments. The company is one of the leading suppliers of rolled, forged, and machined products. The company is suppliers to various sectors like Automotive, Railways, Farm Equipment, Bearings, Oil & Gas, Power and Construction, Earth Moving & Mining, both in India & overseas markets. In Q3FY22, Ramkrishna Forgings (RMKF) delivered a strong performance. Revenue grew by 51% YoY, on the back of a volume increase of 16% YoY, owing to healthy export volumes. EBITDA margin on better operating leverage and pricing power.
We believe the company can continue to win more new orders in auto and non-auto segment over the coming years on the back of launch of new products and an expanding overseas reach. Moreover, recent traction in Oil & gas (contributing ~10% of revenue) would aid higher growth from high margin non-auto segment. The company’s Railway business is currently doing well with a revenue of Rs30-40mn/quarter and expects it to double by 1QFY23E on YoY basis. RMKF expects its export/domestic revenue mix to be ~50%/50% by FY23 and targets 60%/40% in FY24.
The stock trades at PE of 11x FY23 consensus estimates. We expect a strong CV upcycle over the next 1-2 years, domestically as well as globally. Moreover, its new margin territory coupled with healthy order wins across segments and geographies could support its rerating. RMKF targets to be a net debt free company in next three years. However, its debt has increased to Rs13 bn from Rs11 bn in FY21.