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Bharat Forge: In the investment phase - Views on News from Equitymaster
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Bharat Forge: In the investment phase
Jan 17, 2006

Performance Summary
Led by higher export growth in 3QFY06, Bharat Forge, a globally competitive forging manufacturer, posted a 29% YoY rise in sales and a proportionate growth in net profit. The net profit growth was despite operating margins declining by 350 basis points. While the domestic growth was slower in the third quarter, for the first nine months, exports and domestic revenues have increased neck-to-neck.

(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Net sales 3,109 3,994 28.5% 8,578 11,395 32.8%
Expenditure 2,233 3,008 34.7% 6,202 8,552 37.9%
Operating profit (EBDITA) 876 986 12.7% 2,376 2,843 19.6%
EBDITA margin (%) 28.2% 24.7%   27.7% 24.9%  
Other income 4 161 4017.9% 53 387 632.8%
Interest (net) 90 153 71.4% 251 393 56.6%
Depreciation 136 191 41.1% 391 516 32.1%
Profit before tax 654 802 22.6% 1,787 2,321 29.8%
Extraordinary item - -   - -  
Tax 240 270 12.3% 655 781 19.3%
Profit after tax/(loss) 414 533 28.6% 1,133 1,540 35.9%
Net profit margin (%) 13.3% 13.3%   13.2% 13.5%  
No. of shares (m) 197.8 220.5   197.8 220.5  
Diluted earnings per share (Rs)*         11.1  
Price to earnings ratio (x)         35.3  
(*trailing twelve months - consolidated)            

What is the company's business?
Bharat Forge (BFRG) is the second largest forging company in the world with an installed capacity of 130,000 tonnes in FY05. It is the largest exporter of auto components from India and leading chassis component manufacturer in the world (Source: Company). BFRG manufactures a wide range of critical components for passenger cars, commercial vehicles and diesel engines. On the domestic front, the company's list of clients include Tata Motors, Ashok Leyland, Eicher, M&M, Toyota and Maruti Udyog. On the international front, the client list consists of Volvo, Caterpillar, Toyota, Renault and Daimler Chrysler, to name a few. In the last two years, the company has expanded its presence geographically through acquisitions (in FY04, it acquired two German companies and in 1QFY06, Federal Forge of US was acquired). With CDP and Aluminiumtechnik in its kitty, it has gained a strong foothold in Europe.

What has driven performance in 3QFY06?
Expansion benefits: BFRG has been in a major capacity expansion binge (expected to be completed in 2005-06), which would increase its passenger car crankshaft capacity to approximately 650,000 numbers per year and increase its forging capacity to 240,000 tonnes. Further, it is also expanding its capacity of front axle beams to 1 m units. With orders already booked, the company's robust export growth is not surprising. The domestic growth, however, is showing signs of plateauing with revenues growing by only 6% YoY in 3QFY06. In our view, exports will be the major growth driver for the company in the years to come. Our full year topline estimate is fairly in line with the company's nine months performance.

Cost break-up...
(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Raw materials 1,431 1,880 31.4% 3,912 5,338 36.5%
% sales 46.0% 47.1%   45.6% 46.8%  
Manufacturing cost 516 658 27.5% 1,389 1,860 33.9%
% sales 16.6% 16.5%   16.2% 16.3%  
Staff cost 186 251 35.2% 516 708 37.3%
% sales 6.0% 6.3%   6.0% 6.2%  
Other expenses 178 323 80.9% 711 881 23.9%
% sales 5.7% 8.1%   8.3% 7.7%  
Change in stock (77) (104) 34.5% (325) (235) -27.9%
% sales -2.5% -2.6%   -3.8% -2.1%  

Margins stabilise: Though operating margins have shrunk on a YoY basis, if one were to consider the trend in operating margins over the last four quarters, it has been at the same level. The decline could be attributed to two factors. Firstly, the expenses incurred towards capacity expansion are up-front in nature and it takes time for the new facility to stabilise and then, gain in scale. Secondly, the pressure on account of the rise in steel price is a known factor and it is aptly reflected in raw material costs (as a percentage of sales, it is higher by 120 basis points (1.2%) in 9mFY06). We had factored in a margin improvement in operating margins based on the premise of softer input cost in the second half of the fiscal year. While we continue to have this view, there is a need to re-look at our full year margin estimates.

Surplus cash boosts net profit: In our calculation, BFRG raised in excess of Rs 10 bn (through GDR and FCCB) to fund its capacity expansion and acquisitions in Europe. Since these funds are to be invested in a phased manner (apart from existing capex), the company was able to generate investment income from the surplus cash. We have factored in Rs 650 m for FY06, against which other income in 9mFY06 stands at Rs 387 m (60% of our estimates). Higher interest cost could be attributed to interest payable on FCCB until conversion into equity shares while depreciation charges have increased owing to the capacity expansion.

Consolidated profits also higher: On a consolidated basis i.e. including the acquisitions in Europe and US, net profit for the first nine months of the fiscal year have risen by 30% YoY while the total income was higher by 59% YoY. We expect the net profit of key subsidiaries to grow at a CAGR of over 20% in the next three years and therefore, will contribute to around 15% to 17% of total profitability on a conservative basis.

What to expect?
At Rs 391, the stock is trading at a price to earnings multiple of 16 times our estimated FY08 earnings. We recommend a HOLD on the stock, considering the visibility in earnings growth and the upside from restructuring of subsidiary operations. In the auto ancillary sector, Bharat Forge remains our preferred play.

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