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Bharat Forge: Slow and steady! - Views on News from Equitymaster

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Bharat Forge: Slow and steady!
Jan 22, 2007

Performance Summary
Bharat Forge, India’s largest forging company has put up a decent show during 3QFY07. Driven by a 23% YoY jump in exports, the topline of the company has grown by 20% YoY in the quarter under review. While there has been a reasonable improvement in operating margins, higher interest costs and depreciation outgo have restricted the bottomline growth to 18%. Performance during the nine months ended December 2006 has been no different with the bottomline growing at a marginally lower rate of 18% as against the topline growth of a little over 18%. The consolidated performance has been even better as expansion in operating margins have transformed a rather average 8% topline growth into an impressive 23% bottomline growth, on a YoY basis during 3QFY07. However, if we consider the same tax provisioning as corresponding previous quarter, then the bottomline growth falls to 18%.

Financial performance: Standalone snapshot
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Net sales 3,994 4,771 19.5% 11,395 13,484 18.3%
Expenditure 3,008 3,532 17.4% 8,552 10,051 17.5%
Operating profit (EBDITA) 986 1,239 25.6% 2,843 3,433 20.7%
EBDITA margin (%) 24.7% 26.0%   24.9% 25.5%  
Other income 161 162 0.9% 387 587 51.6%
Interest (net) 153 215 40.4% 393 588 49.5%
Depreciation 191 253 32.1% 516 731 41.7%
Profit before tax 802 933 16.3% 2,321 2,701 16.4%
Tax 270 303 12.5% 781 889 13.8%
Profit after tax/(loss) 533 630 18.2% 1,540 1,812 17.7%
Net profit margin (%) 13.3% 13.2%   13.5% 13.4%  
No. of shares (m) 220.5 222.6   220.5 222.6  
Diluted earnings per share (Rs)* 9.6 11.3   9.2 10.8  
Price to earnings ratio (x)**         33.8  
(* annualised, ** on trailing twelve months earnings)

What is the company’s business?
Bharat Forge (BFRG) is the second largest forging company in the world with an installed capacity of 200,000 tonnes in FY06, which will increase to 340,000 tonnes in FY07. It is the largest exporter of auto components from India and leading chassis component manufacturer in the world. BFRG manufactures a wide range of critical components for passenger cars, commercial vehicles and diesel engines. On the domestic front, the company's clientele includes Tata Motors, Ashok Leyland, Eicher, M&M, Toyota and Maruti Udyog. On the international front, the 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, in 1QFY06, Federal Forge of US was acquired and in the same fiscal, it acquired Imatra Kilsta of Sweden). With CDP and Aluminiumtechnik and now Imatra Kilsta in its kitty, it has gained a strong foothold in Europe.

What has driven performance in 3QFY07?
The de-risking benefits: The company’s topline performance during the quarter was characterised by a 23% YoY jump in exports and a 17% YoY jump in domestic revenues. Infact, had it not been for the rupee appreciation, the growth in exports would have been even higher. Bharat Forge operated at 71% capacity utilisation levels during the quarter and as it ramps up the remaining capacity, greater growth in topline cannot be denied. Further, while it faced pressure in the commercial vehicle chassis components space, its traditional export stronghold, thanks to its efforts at de-risking its business model, the same was offset by a 30% jump in passenger car and heavy-duty components exports. The same strategy is benefiting the company on the domestic front, as it has been gaining market share in passenger cars as well as farm equipment segment. Further, with the company taking significant steps towards venturing into non-automotive forgings space such as energy, aerospace and oil and gas, greater comfort could be derived vis-ŕ-vis the stability in revenues going forward.

Cost break-up…
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Raw materials 1,776 2,175 22.4% 5,104 5,977 17.1%
% sales 44.5% 45.6%   44.8% 44.3%  
Staff cost 251 278 10.8% 708 797 12.5%
% sales 6.3% 5.8%   6.2% 5.9%  
Manufacturing expenses 657.80 837.76 27.4% 1,860 2,374  
% sales 16.5% 17.6%   16.3% 17.6%  
Other expenditure 323 242 -25.1% 881 903 2.6%
% sales 8.1% 5.1%   7.7% 6.7%  

Margin expansion – Exchange gain kicker: A gain to the tune of Rs 80 m arising out of sale of foreign currencies has helped the company offset higher raw material costs and manufacturing expenses and expand operating margins by 130 basis points. The company faced higher transportation and forwarding charges during the quarter and hence the pressure on raw material costs. Sale of machined components as a percentage of total sales remained at around 45% and this further restricted margin expansion, as machined components are typically higher value add products. With the same expected to rise to 65% of sales, scope for margin expansion does exist.

Capital and finance charges suppress profits: With interest costs jumping by 40% YoY during the quarter and depreciation outgo increasing by 32%, the company’s bottomline growth was restricted to 18%. However, with new orders coming in, depreciation as a percentage of sales is likely to come down in the coming quarters, enabling the company to take advantage of the benefits of operating leverage.

As far as the consolidated performance is concerned, while topline has been a concern, improvement in operating margins and a bottomline growth of 23% is not bad considering the fact that full fledged integration benefits are yet to trickle in. With the company opting to maintain a strategy of improving internal efficiencies first, robust topline growth may still be some quarters away.

Consolidated snapshot
(Rs m) 3QFY06 3QFY07 Change
Net sales 9,406 10,174 8.2%
Expenditure 8,026 8,504 6.0%
Operating profit (EBDITA) 1,380 1,670 21.0%
EBDITA margin (%) 14.7% 16.4%  
Other income 161 197 22.3%
Interest (net) 204 254 24.5%
Depreciation 366 461 26.2%
Profit before tax 971 1,151 18.5%
Tax 344 381 10.8%
Profit after tax/(loss) 627 770 22.8%
Net profit margin (%) 6.7% 7.6%  

What to expect?
At Rs 348, the company is trading at a rich valuation of 34 times its trailing twelve-month earnings. Given the company’s efforts at identifying new areas of growth and strong profit margins, we remain confident of its abilities to continuously enhance shareholder value over a long-term period. As such, we maintain our positive view on the stock.

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