ICICI Direct : Buy Eveready Industries

(BSE: 531508 | NSE: EVEREADY | ISIN: INE128A01029)

Eveready Industries, the leader in batteries and flashlights, would benefit from the increased need for affordable portable energy. Improving margins due to softening of raw material cost are expected to boost its profitability.

Company Background Eveready Industries manufactures dry cell batteries, flashlights and electrolytic manganese dioxide. The company also markets packet tea, a fast-growing business that is poised for greater gains in market share. It is virtually the only flashlight manufacturer in the market. It has also got presence in insect repellent segment, with coils in its product portfolio. During Q2FY08, the company approved the amalgamation of a wholly-owned subsidiary, Powercell Battery India, with itself, which will be effective from April 1, 2007. It is now awaiting the approval of the Calcutta High Court. The company notched a turnover of Rs 873 crore in FY07 and Rs 435 crore in H1FY08. Recently, it signed a MoU with HDIL, a realty firm, for transfer of lease land at Navi Mumbai. Eveready has also received earnest money of Rs 11.5 crore for the same. Eveready’s strategy of diversifying into new products will add scale and boost profitability.

Investment Rationale Increasing its market share in batteries Eveready _s market share in batteries increased to 47.5%, which is one of the highest in the category. Batteries contribute 77% to the company _s total sales. Off-take of batteries is driven largely by growth in the off-take of its applications. The growing need for portable power and the advent of a number of battery-operated gadgets has boosted demand for batteries. Since these gadgets have applications in everyday use, demand for batteries is not cyclical and largely unaffected during the recent downturns. Last year, due to a steep rise in zinc prices, and the subsequent hike in product prices, sales volumes saw an 8% de- growth. However, with zinc prices softening, and the benefits of the decline being passed on, sales are expected to rise again.

Raw material cost to decline Zinc is the major raw material for batteries. For Eveready, zinc accounted for 35% of total raw material cost in FY07. This proportion has risen from 21% in FY06, even though production hasn’t increased substantially owing to rise in zinc prices. With the decline slide in zinc prices, EBIDTA margins, which had taken a beating in last couple of years, improved from 4.1% in Q1FY08 to 10.2% in Q2FY08.

Presence in other tea brands like Tez, Jaago, Premium Gold, Classic Packet tea contributes 9% to the company’s total sales. Tea prices are expected to increase by Rs 5 to Rs 7 in FY08 as there is hardly any carry forward of stock from last year. Hike in tea prices will also have a positive impact on sales and realisations.

Key Concerns EBIDTA margins largely dependent on zinc prices If metal prices don’t decline as expected, the rising prices of zinc and copper would continue to be an area of concern in the manufacture of brass flashlights and batteries. High zinc prices will put a squeeze on the company’s margins. Demand could also suffer as a reaction to price increases.

Financials Sales and operating margins to improve Eveready is expected to witness better growth in sales on account of rise in tea prices and softening metal prices. Zinc and copper are the essential raw materials for flashlights and batteries. We expect net sales to grow marginally higher between 7%-8% in FY08 from 5.6% in FY07 (Rs 873 crore). During FY07, growth was impacted due to de-growth in volumes owing to high price hikes. The company posted a net profit of Rs 1.17 crore in Q1FY08 against Rs 2.05 crore in Q1FY07, giving signals of coming to profit. Though pressures on operating margins will remain in FY08, by FY09E the company should see high growth in sales value and volumes, along with margin improvements on account of lower raw material cost and higher realisations.

Valuations At the current price of Rs 69, the stock trades at 0.56x market cap/sales. This is low compared to peers, where the ratio is greater than 1.2x. Both the batteries and tea businesses are expected to improve their overall EBIDTA contribution going forward. With a turnaround in margins and the company coming out of the red, we believe there the stock would be re-rated. We recommend a buy with a target price of Rs. 83, an upside of 20% over a 3-6 month timeframe.

Technical Outlook The stock gained 25% this week. On the weekly charts, a long engulfing bull candle was formed. Average volumes were two times more than that in the previous week, which indicates a strong breakout. A lot of accumulation took place between the Rs 55-60 levels, and the stock is currently trading above its 200 EMA. It has strong support at around Rs 53. On the higher side, it could face resistance at the Rs 81 levels. A close above these levels would see prices surge to Rs 87 and Rs 92 levels.

Every week ICICIdirect research team will select a stock based on fundamental and/or technical parameter, which is likely to return 20% over a 3-6 month perspective.

Investment in equity shares has its own risks. Sincere efforts have been made to present the right investment perspective.The information contained herein is based on analysis and up on sources that we consider reliable. I, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and I am not responsible for any loss incurred based upon it.& take no responsibility whatsoever for any financial profits or loss which may arise from the recommendations given in this blog.