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Bharat Forge: One notch above - Views on News from Equitymaster
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Bharat Forge: One notch above
May 24, 2006

Performance summary
Bharat Forge, one of the most competitive forging manufacturers in the world, announced its full year results yesterday. While the topline, on a standalone basis, grew by 29% YoY, the growth at the consolidated level was over 50% YoY, mainly led by acquisitions. Though operating margins were lower, once the capacity utilisation of new facilities improves, the company will benefit from operating leverage. The consolidated profitability was lower than our estimates, as the subsidiary turnaround is taking longer than we anticipated.

(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net sales 3,613 4,384 21.4% 12,191 15,779 29.4%
Expenditure 2,721 3,331 22.4% 8,923 11,883 33.2%
Operating profit (EBDITA) 892 1,053 18.1% 3,268 3,896 19.2%
EBDITA margin (%) 24.7% 24.0%   26.8% 24.7%  
Other income 21 144 579.4% 74 531 617.8%
Interest (net) 84 155 83.2% 336 548 63.3%
Depreciation 135 214 58.7% 526 730 39.0%
Profit before tax 693 828 19.4% 2,481 3,149 26.9%
Extraordinary item - -   - -  
Tax 210 298 42.0% 864 1,079 24.8%
Profit after tax/(loss) 484 530 9.6% 1,616 2,070 28.0%
Net profit margin (%) 13.4% 12.1%   13.3% 13.1%  
No. of shares (m)       197.8 222.3  
Diluted earnings per share (Rs)         9.3  
Price to earnings ratio (x)         37.5  

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 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 FY06?
Sales - Acquisitions and expansions: Domestic revenues grew by 30% YoY during the fiscal, led by a 11% rise in CV sales (excluding LCV segment, the CV sector registered a growth of 1% YoY in volume terms) and a 9% increase in car sales. Though exports grew at a slower pace in FY06 (28% YoY), we believe that once the capacity expansion is through, exports will far outgrow the domestic market. The growth is overall sales has also got to be viewed in light of augmentation of capacity by 23% YoY. As far as the capacity ramp-up is concerned, the crankshaft capacity will increase from 513,000 units per annum (UPA) in June 2006 to 650,000 by October 2006. Overall, we believe that the company is on a strong footing to increase exports and widen its geographical reach in the next three years.

Cost break-up...
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Raw materials 1,606 2,260 40.8% 5,518 7,598 37.7%
% sales 44.4% 51.5%   45.3% 48.2%  
Manufacturing cost 538 675 25.5% 1,927 2,535 31.6%
% sales 14.9% 15.4%   15.8% 16.1%  
Staff cost 177 209 18.3% 693 917 32.4%
% sales 4.9% 4.8%   5.7% 5.8%  
Other expenses 353 247 -30.0% 1,064 1,128 6.0%
% sales 9.8% 5.6%   8.7% 7.1%  
Change in stock 48 (60) -226.2% (278) (295) 6.1%
% sales 1.3% -1.4%   -2.3% -1.9%  

Input impact on margins: The decline in operating margins YoY is due to a combination of higher raw material costs as well as increased overheads incurred towards augmentation of the capacity (including manpower). As per the company, while the capacity was expanded to 240,000 tonnes in FY06, only 2/3rd is operational. However, the company has added manpower and incurred overheads for the capacity installed. In the medium-term, we expect operating margins to improve once the new capacity commence production. In fact, the company has incurred Rs 300 m towards additional overheads, which if we exclude from expenses in FY06, the decline in margins is actually 20 basis points (0.2%). Further, if steel prices soften, like they have in the last two months, the pressure from customers will ease as far as prices are concerned (a significant part of the steel price decline will be passed on to the consumer). At the consolidated level, operating margins are lower at 17%. While we expect the consolidated operating margins to remain lower than standalone performance, we believe that there is scope for improvement in the same in light of the restructuring process.

Consolidated financials…
(Rs m) FY05 FY06 Change
Net sales 19,934 30,189 51.4%
Expenditure 15,701 24,962 59.0%
Operating profit (EBDITA) 4,233 5,227 23.5%
EBDITA margin (%) 21.2% 17.3%  
Other income 80 662 728.9%
Interest (net) 411 683 66.5%
Depreciation 772 1,281 65.9%
Profit before tax 3,130 3,925 25.4%
Extraordinary item - -  
Tax 1,119 1,419 26.8%
Profit after tax/(loss) 2,011 2,505 24.6%
Net profit margin (%) 55.7% 57.1%  
No. of shares (m) 197.8 222.3  
Diluted earnings per share (Rs)   11.3  
Price to earnings ratio (x)   31.0  

Other income up: The sharp spurt in other income, which is as per our estimates, could be attributed to the income from surplus cash invested. As a matter of fact, during the year, Bharat Forge raised around US$ 328 m (Rs 15 bn) to fund its capacity expansion plans and inorganic growth opportunities. While the expansion is likely to be completed over the next 12 to 18 months, the surplus cash in the interim was invested, which is reflected in higher other income. The increase in interest cost is due to interest on FCCB issues, while depreciation charges are higher owing to the ongoing expansion. As for our estimates, while we were broadly in line with the actual performance in FY06 at the PBT level, at the consolidated level, our estimates were higher (as we expected significantly higher contribution from CDP Germany).

Over the last few quarters: While the rate of growth at the topline has slowed down, we expect acceleration in the same in light of the aggressive expansion plans. Even as operating margins are down on a YoY basis, they are stable during the course of the year despite increased overheads. This is a commendable show.

What to expect?
At Rs 349, the stock is trading at a price to earnings multiple of 31 times its FY06 earnings. Given the expansion plans and the restructuring of overseas operations, we believe that net profit, over the next two to three years, is likely to grow at a CAGR of over 25%. We had recommended the stock as a HOLD in February 2006 with a target price of Rs 510. We continue to have a positive view on the stock from a long-term standpoint.

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