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Bharat Forge: Will valuations hold?

Feb 20, 2003

Bharat Forge (BFRG) is among the select few Indian companies that operate on a global scale and are increasing making a dent in market share of international players. After restructuring, the company's focus on increasing contribution from exports have yielded positive results, which is also reflected in its share price movement on the stock markets. The stock is trading at its 52-week high and has appreciated almost 170% since February 2002. Given this backdrop, we take a look at the company's first nine months performance and ascertain whether current valuation levels are sustainable over the long-term.

(Rs m) 3QFY02 3QFY03 Change 9mFY02 9mFY03 Change
Net sales 1,113 1,677 50.7% 3,096 4,434 43.2%
Other Income 2 15 504.2% 44 18 -59.2%
Expenditure 812 1,190 46.6% 2,310 3,087 33.6%
Operating Profit (EBDIT) 301 487 61.7% 786 1,347 71.3%
Operating Profit Margin (%) 27.1% 29.0%   25.4% 30.4%  
Interest 104 93 -10.3% 340 312 -8.1%
Depreciation 98 105 7.1% 290 310 7.1%
Profit before Tax 102 303 198.7% 201 743 269.7%
Tax 38 90 133.3% 72 232 222.1%
Profit after Tax/(Loss) 63 214 238.5% 129 511 296.3%
Net profit margin (%) 5.7% 12.7%   4.2% 11.5%  
No. of Shares (m) 37.7 37.7   37.7 37.7  
Diluted Earnings per share (Rs)* 6.7 22.7   4.6 18.1  
P/E Ratio (x)   12.0     15.1  
(* annualised)            

Before going any further, a brief overview of the company is of significance. BFRG is the market leader in the forging industry with a commanding market share in the domestic market. It is also a major supplier to many international original equipment manufacturers (OEMs). As a result, the company's performance is highly dependent on the automobile sector. Apart from catering to the automobile-forging segment, it has ventured into supply of components for drilling equipments used in oil and gas sector where it has already met with some success.

For the first nine months of the current fiscal, revenues have grown at a impressive rate of 43%, which is a result of a sharp spurt in exports. BFRG has also benefited from the sharp reversal in demand trend for commercial vehicles (CVs), which account for a bulk of forging demand in the industry (estimated at more than 70%). While domestic sales were up 13% in 3QFY03 to Rs 1,059 m (59% of revenues), for the first nine months, domestic sales were higher by 7%. Growth in revenues in the third quarter was on the higher side due to the commencement of exports to China (35% of total exports of Rs 747 m in 3QFY03).

Backed by higher capacity utilisation and benefits from the ongoing employee rationalisation initiative is reflected in the form of a rise in operating margins. While expenses pertaining to raw material and manufacturing have increased as a percentage of 9mFY03 sales, employee costs have declined to 8% in 9mFY03 compared to 10% of sales in the same period last year. This has fuelled operating profits. Backed by lower interest outgo and effective tax rate, net profit has almost tripled in 9mFY03.

The stock currently trades at Rs 273 implying a P/E multiple of 15.1x annualised 9mFY03 earnings. Having looked at the historical angle, what does the future hold for players like Bharat Forge? Despite being dependent on the auto sector, are such high valuations warranted? Though we expect domestic sales to grow at a slower rate of around 4% in FY04, exports would continue to drive volume growth and enable the company to sweat assets. The efforts to lower dependency on the auto sector by manufacturing products catering to the oil & gas sector has started to reflect in terms of higher revenues in 9mFY03.

The company is expected to generate revenues of around Rs 500 m per annum for the next four years from Dana Corp of UK (BFRG took over the order book for Dana Corp for supply of forgings to the latter's customers in FY02). This apart, ramp up of exports to Renault and China, will keep volume growth ticking in FY04 and FY05. BFRG won a second long-term Chinese order for supply of engine components after First Automotive Works, for which delivery started in 3QFY03. However, we expect operating margins to stabilise, if not face pressure from the current levels in FY04. Overall, while revenue growth prospects are highly impressive, given the auto ancillary nature of the company, growth expectations seem to have been factored in at current valuation levels.

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