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Bharat Forge: Conf call excerpts
Feb 16, 2006

Post its 3QFY06, Bharat Forge held a conference call to give an insight into the results and its future outlook. We also met the company personally to understand the future strategy. Following are the key excerpts of the same. Performance highlights:On a consolidated basis, though the company has registered a strong topline growth, the same failed to filter in to the bottomline of the company. This was primarily due to the fact that BFL – America (Federal Forge) and Imatra group, which it acquired recently, have been included in the consolidated picture. The margins of these companies are not significant (company did not disclose the figure) and the management needs time (around one year) to restructure them and bring their margins at par with that of its other overseas subsidiaries. The management aims to improve the operating margins of the subsidiaries to around 12% to 14% from the current levels of 7% to 10% (our estimates).

Consolidated picture
Rs m 3QFY05 3QFY06 Change
Total income 5,288 9,567 80.9%
EBIDTA 1,230 1,541 25.3%
Operating margins 23.3% 16.1%  
Net profit 576 627 8.9%
Net profit margins 10.9% 6.6%  

The standalone profitability of the company was affected mainly due to increase in the interest expense on account of hike in Libor rates and also exchange rate loss incurred during the current quarter. The increase in other income should be viewed in light of surplus funds with the company, which is invested in fixed income securities. The increase in depreciation is on account of increase in the capital expenditure plans from Rs 3.5 bn to almost Rs 7 bn, as the company has planned to expand its capacity beyond original estimates.

The Chinese joint venture: Recently, Bharat Forge entered into joint venture (JV) with FAW group of China in forging operations (FAW has an installed capacity of 100,000 tons). Bharat Forge has 52% stake in the JV. The strategy for the same, going forward, will be as follows:

  • Initially, the forging plant will meet the demand of the FAW group. It should be noted that FAW group is a US$ 16 bn group and is amongst the leading automotive player in China. This company aims to improve the productivity of the forging plant, which is less than 50% currently. Bharat Forge aims to raise the productivity to around 70% to 80%. Currently, the forging division is not able to meet the requirements of the group completely.

  • Secondly, Bharat Forge aims to be the key player for its international clients operating in China. As per the management, the initial response from the global player operating in China is positive.

  • After meeting the above demands, the company will also look for export opportunities. It aims to make India and China as the low cost sourcing base for its global operations.

However, currently, there has been an agreement between the two companies for the stake sales. Bharat Forge has made an application to obtain a business license. Thereafter, a new company will be formed, through which, Bharat Forge will acquire 52% stake. Bharat Forge expects the formation of the company to be completed by April 2006. Thus, based on the interaction with the management, we comprehend that the real synergistic benefits will actually accrue post FY07. Having said that, in FY07 consolidated numbers, the revenues and the profits of the Chinese company will be reflected.

Global strategy: With the completion of ‘dual shore capability’ (post the Chinese venture), the company is now putting in-place a global strategy to evolve as an integrated entity. The main objective of the company in the coming years will be to leverage the recently acquired global scale.

The key components of the strategy are as follows:

  • Develop a global strategy for procurement of raw materials with a clear focus on quality, cost and sustained availability

  • Currently, Bharat Forge has customers that are common in one or more subsidiaries. The company aims to devise a strategy to maximize the synergistic value by reducing the number of interface between itself and its customer.

  • The company aims to improve the financial performance of the group by exploiting the dual shore capability. It aims to do the low cost, low precision work in India and China and the high end work in the foreign subsidiaries. Similarly, it aims to improve the productivity at different locations by implementing the superior technology of other subsidiaries.

Apart from this, the company aims to go up the value chain by becoming a ‘designing and product development partner’ as compared to the current position of being predominantly a contract manufacturer.

Capex: Initially Bharat Forge had outlined a capital expansion plan of Rs 3.5 bn. However, the same has been increased to Rs 7 bn. The increase in capex is due to following:

  • Increase in the forging capacity to 240,000 tons instead of original plan of 190,000 tons. The entire capacity is expected to be on-stream by October 2006 and the optimum utilisation will reflect from the last quarter of FY07.

  • Setting up an additional crankshaft facility (initially the plan was for 3 facilities)

  • Setting up of 5 chassis component units (not under initial plan).

The reason attributed to the increase in the capital expansion plan is the increasing demand from its customers and strong outsourcing demand going forward. Most of the capex plans (around 80%) will be accrued in the books by the end of FY07.

Increase in raw material expenses:In 9MFY06, the raw material expenses (as a % of sales) have increased by around 120 basis points. This is mainly due to the changes in the sales prices (numerator) and raw material costs (denominator) used for calculating the ratio (see the table below ).

Changes in raw material prices (hypothetical example)
Rs m Original scenario 2% increase 2% decrease
Sales price (Rs) 100 102 98
Raw material costs (Rs) 50 52 48
% sales 50.0% 51.0% 49.0%

The management clarified that the fluctuations in the steel prices are a pass-thru and the company is not affected by the changes in the steel prices.

Pricing pressures: Bharat Forge has 25% operating margins. As per the management, the company is witnessing pricing pressures due to the fact that global vehicle manufacturers are witnessing the same trend. However, the company aims to counter that by rising the value chain and optimizing the economies of scales.

What to expect?
At Rs 416, the stock is trading at a price to earnings multiple of 16.3 times our consolidated numbers Based on the new valuation band (16x to 20x), we believe that the stock is fairly valued. Having said that, in our consolidated numbers, we have not factored in the earnings of the recent European and the Chinese ventures as not much of details are available at the current juncture. To that extent there is upside to our consolidated numbers. Considering the above factors we would recommend a HOLD on the stock.

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