Moser Baer: A compact option?

Recommendation

Risk averse: Hold/Book profits on uptrend

Risk bearing: Buy on declines - Medium term

Krishnan Thiagarajan

AT THE current market price, the Moser Baer stock trades at a price earnings multiple of 6.6 times its annualised earnings of Rs 42.60 per share.

At this price, investors with a low-risk appetite can hold the stock and book profits on any uptrend linked to the broad market. However, investors willing to take risks with a medium-term perspective may consider buying the stock at declines of around 10 per cent from the prevailing market price.

Suitability: For investors with a broad-based portfolio of software service stocks, Moser Baer, as a fundamentally sound hardware stock, provides scope for portfolio diversification. Given the sharp slump in realisations in the data storage market over the past year, and threat of technological obsolescence, the stock may not be suitable for the risk-averse. But for the risk-taker with at least a one-year investment horizon, Moser Baer is a good investment candidate.

Background: One of the key facets of Moser Baer's growth has been its ability to make a smooth transition from a magnetic media manufacturer (floppy diskettes) to an optical media manufacturer - CD-Recordables (CD-R)/CD-Rewritables (CD-RW). Since mid-1999, when it set up its initial capacity, it has ramped up capacity over the last couple of years, reaching 380 million units by 2000-01. It is now working on doubling the CD-R capacity to 760 million units by end-2001-02.

By offering strategic equity stakes of around 54 per cent to three private investors - JF Electra, Warburg Pincus and International Finance Corporation - over the last year or so, Moser Baer has managed to achieve comfortably financial closures for its expansion projects. It is likely to use a mix of debt and internal accruals to finance its expansion programmes.

These series of expansions have helped Moser Baer record a scorching pace of growth in revenues, both sequentially and year-on-year, for the past couple of years. Although the growth in post-tax earnings slowed down in the first two quarters of 2001-02 on account of lower prices of CD-R, any marked improvement in prices will contribute to a healthy improvement in the bottomline.

Strengths: By making a foray into optical media, Moser Baer has been able to keep pace with market trends, improve its operating profit margins in line with its peers and arrest the possible decline in revenues/margins on account of the slowdown in demand from the floppy diskette market.

The benefits of the huge expansion in CD-R capacity are slated to accrue in the form of economies of scale and help clock higher volume growth and offset lower realisations for Moser Baer on the revenue front. In addition, even a cursory examination of cost structures of Moser Baer with that of some Taiwanese manufacturers - its biggest competitors - suggests that the company enjoys considerable cost advantages over its Taiwanese peers. This is slated to help Moser Baer protect its margins and bottomline in future.

Despite a slowdown in tech spending, some key market studies project that barring short-term hiccups, the demand for data storage (especially CD-R) will remain steady in the near term. As multimedia, audio and internet usage proliferate, it may generate significant demand for the storage market, especially for optical media. Given the consolidation among major Taiwanese players in the past year or so, it appears that oversupply may be a thing of the past and a healthy demand-supply gap may emerge in future.

Moreover, as Moser Baer has already created a good distribution network and brand presence in the optical media market over the past couple of years, market penetration may not pose such a big problem. The company is marketing tie-ups of at least five of the largest OEMs in the world, and this may provide greater visibility to revenue streams on an expanded production capacity. To enhance further its strengths in marketing, it has made investments in two overseas companies - Capco Luxembourg S.a.r.l and Glyphics Media Inc - aimed at penetrating the markets in Europe, South and North America.

Risks: The two biggest risks Moser Baer faces are pricing and technological obsolescence. The pricing risk is basically a likely sharp fall in international prices of CD-R in the international market, on the lines of a decline in prices in the 2000-01 fourth quarter. Although the prices have recovered marginally since then, the prospect of a decline to the levels touched in the 2000 fourth quarter cannot be ruled out. If it does, both the margins (that slipped to 48 per cent in the 2001-02 second quarter from 53 per cent for 2000-01) and the bottomline of Moser Baer could suffer a steep fall.

The competitive pressures from major Taiwanese manufacturers such as Ritek, CMC or Prodisc, may further add to the pressures on realisations for Moser Baer.

Second, it is hard to predict the product life cycle of, say, CD-R in a highly dynamic data storage market. Though the risk of technological obsolescence is present in any tech industry, it is significantly higher in the optical media sector as there are several products already available in the pipeline such as DVD-Rs or large form factor opticals with higher data storage capabilities.

As the price-performance ratio of these new products is still unattractive and skewed heavily in favour of the CD-R market, they may not pose an immediate threat. But, in this dynamic industry, as newer storage standards emerge, prices are bound to drop sharply in a short period of time and that remains a major threat for Moser Baer. At the same time, to retain its competitive edge in the market, Moser Baer has the option of investing in newer products such as DVD-Rs and other upgrades, depending on the market conditions.