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Bharat Forge: Cost of expansion - Views on News from Equitymaster

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Bharat Forge: Cost of expansion
Jan 21, 2008

Performance summary
  • Standalone sales grow 17% YoY, courtesy a similar growth in exports.

  • Pressure on costs has led to the operating margins eroding by 150 basis points (1.5%).

  • Bottomline growth suffers a decline of 8% YoY, as higher interest expenses and depreciation charges take toll.

  • Consolidated bottomline falls by 4% YoY, in sharp contrast to the 11% growth in topline. Here too, higher depreciation and interest charges have played spoilsport.

Financial performance: Standalone snapshot
(Rs m) 3QFY07 3QFY08 Change 9mFY07 9mFY08 Change
Net sales 4,771 5,567 16.7% 13,484 16,168 19.9%
Expenditure 3,532 4,204 19.0% 10,051 12,415 23.5%
Operating profit (EBDITA) 1,239 1,364 10.1% 3,433 3,753 9.3%
EBDITA margin (%) 26.0% 24.5%   25.5% 23.2%  
Other income 162 156 -3.9% 587 948 61.6%
Interest (net) 215 294 36.6% 588 801 36.3%
Depreciation 253 353 39.9% 731 1,033 41.4%
Profit before tax 933 872 -6.5% 2,701 2,867 6.1%
Extraordinary income/(expense) - -   (68)    
Tax 303 290 -4.3% 866 959 10.7%
Profit after tax/(loss) 630 582 -7.6% 1,767 1,907 8.0%
Net profit margin (%) 13.2% 10.5%   13.1% 11.8%  
No. of shares (m) 222.7 222.7   222.7 222.7  
Diluted earnings per share (Rs)*         11.4  
Price to earnings ratio (x)*         27.6  
(* on trailing twelve months earnings)

What has driven performance in 3QFY08?
The 16.7% YoY growth in topline during the quarter was once again led by the 17.4% YoY growth in exports, which improved its share in total revenues marginally from 41% in 3QFY07 to 41.5% in 3QFY08. That the company was able to achieve this growth despite the rising rupee is laudable. While exact details are not given, we believe the sustained growth in exports has been possible due to a diversified revenue base of the company not only in terms of geography but also in terms of products.

Domestic sales however, grew at a lower rate of 15% YoY, and quite understandably so, since the domestic auto industry, especially the CV industry, which is the key driver of the company’s revenues, remained subdued during 3QFY08. However, since Bharat Forge’s business model is now quite adequately diversified, both in terms of product segment as well as geographies, the impact on the overall standalone topline was rather limited. With the company now planning to enter the non-automotive forgings segment, the influence that the domestic auto industry exerts on the company’s fortunes will further reduce. On the consolidated front, topline has grown by a little lower 11% YoY, due largely to the mature nature of almost all its overseas businesses.

The standalone operating margins have fallen during the quarter on a YoY basis. While the company has done well to check its raw material costs, higher staff costs and other expenses have combined to lop off 150 basis points from the company’s third quarter operating margins. The damage has been higher for the nine-month period, where margins have fallen by 220 basis points. On the consolidated front though, damage has been minimal, as operating margins have slipped by just 40 basis points.

Cost break-up…
(Rs m) 3QFY07 3QFY08 Change 9mFY07 9mFY08 Change
Raw materials 2,183 2,472 13.3% 6,007 7,319 21.8%
% sales 45.7% 44.4%   44.5% 45.3%  
Staff cost 278 381 37.1% 797 1,072 34.6%
% sales 5.8% 6.8%   5.9% 6.6%  
Manufacturing expenses 830 984 18.5% 2,343 2,813 20.0%
% sales 17.4% 17.7%   17.4% 17.4%  
Other expenditure 242 367 51.8% 904 1,211 33.9%
% sales 5.1% 6.6%   6.7% 7.5%  

Interest expenses and depreciation charges have gone up substantially during the quarter and this has led to the standalone bottomline decline of 8% YoY. Unlike the previous quarters, the other income has not come to the rescue of the company, as surplus funds seemed to have been diverted towards capex. The 9mFY08 bottomline though has shown a modest growth of 8% YoY, thanks mainly to the 16% YoY growth that the company notched up during the first half of the current fiscal. With the domestic business contributing the maximum to the overall bottomline, the fall in standalone bottomline has also led to a 4% YoY decline in the consolidated bottomline of the company.

consolidated financials
(Rs m) 3QFY07 3QFY08 change
Net sales 9,709 10,800 11.2%
Expenditure 8,101 9,050 11.7%
Operating profit (EBDITA) 1,607 1,750 8.9%
EBDITA margin (%) 16.6% 16.2%  
Other income 193 194 0.7%
Interest (net) 233 325 39.4%
Depreciation 450 545 21.2%
Profit before tax 1,118 1,075 -3.9%
Extraordinary income/(expense) - -  
Tax 375 365 -2.8%
Profit after tax/(loss) 742 710 -4.4%
Net profit margin (%) 7.6% 6.6%  
No. of shares (m) 222.7 222.7  
Diluted earnings per share (Rs)* 13.3 12.6  
Price to earnings ratio (x)**   25.0  
(* on trailing twelve months earnings)

What to expect?
At the current price of Rs 315, the stock is trading at a multiple of 12 times our estimated FY10 earnings. While the current valuation levels may look a little steep, especially against the backdrop of even the auto companies, the company’s expansion plans, especially in the non-automotive forgings space will give its earnings a big boost in the medium term. Given Bharat Forge’s strong execution skills and efforts at continuously adding value to its customers, we remain positive on the long-term prospects of the company.

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