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Moser Baer: Double-whammy!

Feb 11, 2005

Performance Summary
Moser Baer is India's largest player in the optical storage media industry, the third largest in the world and the lowest-cost manufacturer in the world. The company has had another disappointing quarter of operations with net sales falling by 26 % YoY and profits falling by over 100%, pushing the company into the red. This is a continuation of the poor performance of the last quarter. However, there is a slight ray of hope in the form of price stabilization during the quarter with an upward bias going forward.

Financial Performance: A snapshot
(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change
Net sales 4767.8 3539.6 -25.8% 11419.7 8809.5 -22.9%
Expenditure 2796.7 2997.1 7.2% 6761.83 6066.14 -10.3%
Operating profit (EBDITA) 1971.1 542.5 -72.5% 4657.9 2743.3 -41.1%
EBDITA margin (%) 41.3% 15.3% 40.8% 31.1%
Other income 21.5 153.6 615.1% 130.6 502.6 284.8%
Interest 170.3 190.4 11.8% 504.7 545.0 8.0%
Depreciation 708.3 730.0 3.1% 1700.7 2112.1 24.2%
Profit before tax 1114.0 (224.3) -120.1% 2583.1 588.9 -77.2%
Extraordinary income/(expense) - - - - - -
Tax 43.2 10.0 -76.9% 73.2 27.8 -62.0%
Provision for deferred tax - 83.1 - - 222.5 -
Profit after tax/(loss) 1070.8 (317.3) -129.6% 2509.9 338.6 -86.5%
Net profit margin (%) 22.5% -9.0% 22.0% 3.8%
No. of shares (m) 96.8 111.5 96.8 111.5
Diluted earnings per share (Rs)* 38.4 (11.4) 30.0 4.0
Price to earnings ratio (x) 58.5
(* annualised)

What is the company's business?
With a global market share of 18%, Moser Baer is the third largest player in the world in the optical media market and the largest player in India. Products manufactured by the company include optical and magnetic storage media. In the optical media segment, the company manufactures recordable compact disks (CD-R), pre-recorded CD/DVD and re-writable digital versatile disks (DVD-RW). In the magnetic data storage segment, Moser Baer manufactures compact cassettes, micro floppy disks and digital audiotapes. During the period FY99-FY04, the company's revenues and profits have grown at CAGR of 72% and 77% respectively.

What has driven performance in 3QFY05?
Volume growth, a precursor to pricing recovery: As was mentioned by us in our analysis in the previous quarter, management had expected OEMs to carry out inventory correction, the results of which were likely to be seen beginning 3QFY05. This quarter began with inventories depleting at the OEM end, which sequentially cascaded back to manufacturers through the quarter, resulting in improved inventory levels across the industry by December-end. Consequently, manufacturers registered a significant increase in sales volumes, as shipments outstripped production volumes.

As a result, Moser Baer witnessed 68% QoQ growth in sales volumes during the quarter, resulting in a significant reduction in inventories. The fact that the company's sales reduced and losses were incurred during the quarter despite higher volume sales clearly reflects the fact that margins were under tremendous pressure. Going forward, the management expects volume growth and reduction in inventories to continue, given the strong growth in demand for optical media from the consumer segment, which would aid in easing the pricing pressure.

Pricing pressure and high raw material costs impact performance: The company recorded a YoY fall in revenues (26%). This was on the back of the industry going through a very difficult phase, which was characterized by international pricing pressure and an increase in the prices of raw materials, thus resulting in a ‘double-whammy' for players in the industry, including Moser Baer. It must be noted that less than expected demand in the industry led to building of some inventories with manufacturers, which ultimately got reflected in terms of the pricing pressure.

Margin free-fall: Due to the adverse business conditions prevailing during the quarter, the operating margins of the company took a nosedive, falling from about 41 % in the previous quarter to just 15 % in this quarter. The primary reason for this fall was the sharp fall in realisations and increased input costs, particularly polycarbonate. It must be noted that the prices of polycarbonate – the key raw material used in disc manufacturing - rose by as much as 50 % on a YTD basis.

Increased tax provision rubs salt into the wound: Apart from the dismal topline performance and a severe hit at the operating level, an increased provision for deferred tax led to the company recording losses for the quarter.

What to expect?
At the current market price of Rs 235, the stock is trading at a price to earnings (P/E) multiple of 58.5 times annualised 9mFY05 earnings. The management has guided for revenue growth at a CAGR of 25% to 35 % over the next 3 years. It expects the main growth in its business to come from DVDs, as Recordable and Re-writeable DVDs becomes the mainstay of consumer removable data storage medium. The overall market for optical writers is expected to grow by 11 per cent from 2004 to 2005. The company plans to spend $135 million in FY '05 to further increase its capacity to 2.4 billion units. R&D efforts are also continuing on HD-DVD and Blu-ray, which Moser Baer believes will be the next big mass market format and the growth driver for the industry. The company has been witnessing difficult times in the past few quarters due to harsh business conditions. However, the management believes that the worst is over and that the volume growth witnessed by the company in 3QFY05 is a precursor to pricing improvements. However, we believe that one must also consider the risks inherent in the company's business, including technological obsolescence, continuous investment required in innovation and Research and Development (R&D), and the need to build scale and size of manufacturing facilities quickly. Further, the risk for an investor is also enhanced given its earnings volatility and the exposure to international price trends.

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