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Moser Baer: Another challenging quarter

Aug 30, 2005

Performance Summary
Optical storage media major, Moser Baer recently announced results for the first quarter ending June 2005. Although revenues rose at a strong pace, higher raw material costs resulted in margins crashing substantially. Due to the lower margins, lower other income and higher interest costs, the company ended the quarter in the red.

Financial Performance: A snapshot
(Rs m) 1QFY05 1QFY06 Change
Net sales 2,911 3,499 20.2%
Expenditure 1,675 2,768 65.3%
Operating profit (EBDITA) 1,236 731 -40.9%
EBDITA margin (%) 42.5% 20.9%  
Other income 144 119 -16.9%
Interest 177 226 27.6%
Depreciation 669 763 14.0%
Profit before tax 534 (139) -126.0%
Tax 53 (27)  
Profit after tax/(loss) before prior period adjustments 481 (111) -123.2%
Prior period adjustments - -  
Profit after tax/(loss) after prior period adjustments 481 (111) -123.2%
Net profit margin (%) 16.5% -3.2%  
No. of shares (m) 111.5 111.5  
Diluted earnings per share (Rs)* 17.2 -4.0  
Price to earnings ratio (x)   -  
(* annualised)      

What is the company's business?
Moser Baer is India's largest player in the optical storage media industry, the third largest and the lowest-cost manufacturer in the world, with a global market share of over 16% in FY05. 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 FY00-FY05, the company's revenues have grown at a CAGR of 53%, making it one of the fastest growing companies in the Indian technology space.

What has driven performance in 1QFY06?
Demand for DVD-R format powers revenues: Moser Baer witnessed strong shipment volumes during the quarter, despite the traditional demand weakness seen during the summer season. Volumes grew by a strong 44% YoY. Clearly, the major driver behind the growth was the DVD-R format, which grew by as much as 480% YoY. This was aided by a recovery in the average selling price (ASP), which grew 10% sequentially.

The DVD-R formats currently face supply shortages and the company expects this situation to continue in the short term. Given the company's technology leadership and continuing expansion of its DVD-R capacity through the conversion of a few CD-R lines as well as fresh expansion, this is a positive for Moser Baer. It should be noted that Moser Baer had a DVD-R capacity of 2.4 bn units at the end of FY05 and expects to increase this to 2.8 bn units in FY06, spending US$ 125 m. Given a shift in consumer preference towards the DVD-R format, this will benefit the company, going forward. The company has been negotiating price increases with its OEM customers and this has helped revenues to some extent.

High raw material costs cause margin blues: Moser Baer recorded a considerable decline in margins during 1QFY06 to just 20.9% compared to 42.5% in 1QFY05. The main reason for this has been a rise in the prices of polycarbonate (PC), which is the key raw material used by optical media manufacturers like Moser Baer. This rise in PC prices has been caused principally due to the increase in crude oil prices, which have hit record highs in the recent past.

However, it should also be noted that prices of PC have stabilised. The increase in raw material costs was also partly due to the fact that Moser Baer consumed its low-cost inventory in previous quarters. As mentioned above, Moser Baer did manage to drive price increases with its OEM customers, but that was clearly not enough to compensate for the increase in raw material costs and as a result, margins took a severe beating.

Bottomline sees red: Due partly to the considerably lower margins as also lower other income and higher interest costs, Moser Baer ended the quarter in a loss. Higher interest costs were mainly due to an increase in foreign currency debts. Clearly, this has been a very challenging quarter as compared to 1QFY05.

What to expect?
At the current market price of Rs 228, the stock is trading at a price to earnings multiple of 43.6 times FY05 earnings. The management had guided for a revenue growth CAGR of 25% to 35% over the next 3 years. It expects growth from DVDs, as recordable and re-writeable DVDs becomes the mainstay of consumer removable data storage medium.

While Moser Baer has witnessed difficult times in the past few quarters, going forward, with the shift in consumer preference to DVD drives and other competing formats and the favourable demand situation, the company's efforts in boosting capacity in this regard do seem to be on the right track. The main issues during FY06, as highlighted by the management, are the sustainability of price increases and the stability of PC prices. During 1QFY06, input costs appear to have stabilised, which will help Moser Baer to improve its margins. Volumes are also strong and a pricing recovery will enable the company to drive growth further. It should be noted that even though this is traditionally the weak season, shipments still grew at 44% YoY. Also, with the peak winter season coming closer, pricing is expected to become more favourable for manufacturers.

However, we believe that one must consider the risks inherent in the company's business, including technological obsolescence, continuous investment required in innovation and 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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