Year to date, Germany's best performing technology stock has been that of battery producer Varta AG (OTC:VARGF). Recently, the company has raised its guidance the third times in a row. It now expects revenue 2019 of €330 million to €340 million up from an initial forecast of €320 million to €330 million. So far this year, the stock has already increased its price fourfold.
The driver of Varta's outstanding performance is its microbatteries business. Especially the growing market for wireless premium headphones accelerates the company's growth in this segment. Below I will introduce readers to the company and explain in more detail why and how the company is set for considerable growth.
A Short Introduction
I will begin with a short introduction of Varta, as I imagine many readers might not yet be familiar with the company. If you already are, you might just skip this section and continue below.
Varta traces its roots back to 1887 when Adolph Müller set up Germany's first battery factory. The current name dates back to 1962. During its long history the company changed hands many times. In the early two thousands it was split into its respective divisions, several of which were acquired in 2011 by Austrian industrialist and financier Michael Tojner's Swiss Montana Tech Components AG, which retains a 60.35 percent majority stake following the IPO in 2017.
Today, Varta has two main segments: microbatteries and power and energy. The microbatterces segment produces rechargeable lithium cells. Those cells are used in various industrial and consumer electronics products. Varta is also the market leader for hearing aid batteries. The power and energy segment on the other hand offers energy storage solutions for consumers as well as enterprise customers.
Soon, Varta Consumer Batteries will become the third segment as the company has agreed to acquire its formerly spun-off division from Energizer Holdings Inc. (ENR), which has been required by the European Commission to sell it. The car battery's sold under the Varta brand are notably no products of Varta AG as the division has been sold to Johnson Controls International plc (JCI) in 2002.
Energy Density Is Key
Varta's greatest strength is its technological leadership, especially in terms of energy density. The higher the energy density, the more energy can be contained within the same physical dimensions.
The company's products have up to a 30 percent higher energy density compared with competing products. That means that Varta's batteries are smaller yet at the same time stronger and more durable. This is particularly interesting for producers of products for which size and weight are important. Henceforth, especially manufacturers of wearables are a key customer group of Varta batteries.
Energy density is also the key for electric vehicles, as it is crucial to achieve energy capacity - thus range - at an acceptable weight and space consumption. While Varta currently does not operate in this space, there is speculation that it might enter the market in the future. According to various reports, Varta might cooperate with BASF SE (OTCQX:BFFAF;OTCQX:BASFY) and car maker BMW AG (OTCPK:BMWYY;OTCPK:BAMXF).
Headphones Propel Growth
The main driver of growth for Varta is the market for wireless headphones. This market is expected to grow at a rate of about 30 percent per annum. As technological leader, its batteries are especially interesting for manufacturers of premium devices. One customer using Varta products to power its headphones is Apple Inc. (AAPL), as Commerzbank AG's (OTCPK:CRZBF;OTCPK:CRZBY) Stephan Klepp has found out in an rather unusual way - cutting open a pair of AirPod Pros.
Apple will produce approximately 100 million pairs of Air Pods until 2021 according to estimates. One battery per headphone means that alone would be 200 million units. Currently Varta's annual capacity will increase to around 150 million units until 2022. It seems very likely that despite increased capacities, Varta will be able to sell its entire production going forward.
And while the largest player, Apple is by far not the only. Its competitors too are in need of batteries for their respective product. And if they want to challenge Apple, they require the highest quality, i.e. what Varta offers. Thus all in all, the company still has much space to grow not only fast but also profitable.
This dynamic is also visible in the company's financial results. During the first nine month, revenue grew by 22 percent YoY to €248.2 million. Despite increased capital expenditures in order to build up further production capacities, adjusted EBITDA grew even faster, climbing 66.5 percent to €63 million. This represents an adjusted EBITDA margin of 25.9 percent (up from 19 percent YoY).
Debt levels will increase following the completion of the acquisition of the consumer batteries business which the company expects to be priced at about €100 million. Additionally, Varta will acquire the debt of €80 million with the new subsidiary. On the other hand the acquisition will nearly double revenues and increase EBITDA by approximately some €30 million. This makes the debt appear quite manageable. Energizer being forced to dispose of the business, clearly helped Varta to land a very favorable deal here. While not anywhere near as dynamically growing as the microbatteries division, the new third pillar of the business will surely be helpful in financing the acceleration of capacity increases to meet growing demand.
Risks And Downsides
While Varta is surely a great success story, there are nonetheless some risks to be considered. Varta's strength stems from its technological leadership first and foremost. If by any chance competitors will be able to produce similar or better batteries, this could put pressure on the company's profitability and might even endanger growth potential. Especially, if important customers such as Apple might decide to change their supplier. I therefore believe that the greatest risk for Varta is losing its technological leadership.
Another risk is that of quality issues arising. Growing capacity at a fast pace, always means the need to rigorously impose quality control. I am confident, however, that Varta is able to manage said challenge and maintain its high quality standards.
It should also be considered that after quite a rally, the stock already trades at high multiples. This means that the expectation of significant growth is already priced in. Thus, Varta will likely have to constantly proove not only acceptable but outstanding performance going forward.
All in all, I believe that Varta will be able to grow fast and profitable, creating significant value for its shareholders in the process. As long as the company maintains technological leadership and high quality standards, it should be able to outperform the market. Headphones and wearables will continue to be growth drivers. At the same time, the acquisition of the consumer batteries business at favorable conditions adds some stability to the bottom line. For those reasons I believe that Varta's success story is not over yet.
Disclosure: I am/we are long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: All research contained in this article was done with utmost care. However, I cannot guarantee accuracy. Every reader is advised to conduct his or her own due diligence and research.