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Moser Baer: Riding the digital wave!

Sep 23, 2004

Despite the volatility surrounding the Indian markets, stocks from the software sector have rallied during the past few months. While a major proportion of the overall interest towards these stocks was concentrated on a few large players, one relatively small company that has, by far, outperformed the sector stocks over the last one month is Moser Baer. It is the world's third largest and India's only player in the business for optical data storage media. As a matter of fact, while the BSE-Sensex and Infosys have returned 8% and 6% respectively in the month of September 2004, Moser Baer is up 23%. In this article, we take a look at the company's present performance and the potential challenges for it going forward.

Even if one were to consider the performance of these three (Moser Baer, Infosys and Sensex) over the past five years, Moser Baer has outperformed the other two. In fact, while the returns from Moser Baer have been relatively less volatile during this period, investors need to understand that the high volatility in Infosys is more a matter of 'irrational expectations' from investors than the company's performance. However, this should not take away the credit from the optical media major that has been able to grow sales and profits at a faster rate than the software services major. While Infosys' sales and profits have grown at CAGR of 57% and 56% respectively during the period FY99 and FY04, the same for Moser Baer have been higher at 72% and 74% respectively.

In recent times, however, the company seemed to have been under pressure on account of falling prices of optical media like CDs and DVDs. The company's sales have also been hurt due to reduction in purchases by major OEMs (original equipment manufacturers - the company's largest customers) on account of inventory build-up. This challenging market environment that the company currently faces has been on account of over-ordering by the OEM's, distributors and retailers during the period of price increases, and the subsequent corrections carried out by them during the weak demand environment.

Also, in the DVD segment where the company itself is increasing its production capacity, similar large capacity additions by other manufacturers during the third quarter of FY04 resulted in oversupply for DVD-R media, thus depressing their prices. As a matter of fact, Moser Baer's average selling price for optical media fell sequentially by over 16% during the first quarter of FY05. The effect has been seen in Moser Baer's performance during the quarter.

However, the management, as indicated in the company's latest annual report, expects these pressure times to get over soon. In fact, they are of the belief that the situation should start to improve from 3QFY05 onwards as rapid demand growth for DVD absorbs the current oversupply. The management also expects inventory corrections by the end of the third quarter, as winter months are traditionally strong for the global industry.

Putting its money where its mouth is!

Moser Baer, in anticipation of a higher demand going forward, is riding a wave of capacity expansions. After almost doubling its capacity to 2 bn units per annum by the end of FY04, the company is planning to spend US$ 135 m in FY05 to increase its capacity to 2.4 bn units per annum. Moser Baer has already raised a large part of its funding through a GDR issue of US$ 110 m and the project is expected to commence production by 3QFY05.

At the current price of Rs 225, the stock is trading at a P/E multiple of 13x annualised 1QFY05 earnings. However, while this valuation might seem at the higher end of the spectrum, investors need to understand that it seems skewed on account of a profit decline (22% YoY) in the quarter. Going by expectations from SMD (Strategic Marketing Decisions), the leading agency for the global optical media industry, demand for DVD-R media is expected to grow by almost 200% YoY in calendar year 2004, to 2.1 bn units. This should help Moser Baer counter pricing pressure through provision of low cost-high quality products to the global marketplace.

While the stock has outperformed the benchmarks (as mentioned above) over the past five years, the next five could be tumultuous for the company. Given the fact that the optical media industry is facing increasing competition from the Internet and other emerging technologies as faster and cheaper sources of data transfer across the globe, Moser Baer's sales and profitability might be hit going forward. Also, considering the risky nature of business on account of high obsolescence that requires continuous change in technology used for production and thus higher capital investment, investors would do well to gauge their risk return profile well before making their investment decisions. We believe that risks are relatively on the higher side.

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