Bharat Forge: Kick-starting FY06! - Views on News from Equitymaster

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Bharat Forge: Kick-starting FY06!

Aug 8, 2005

Introduction to results
Bharat Forge, the second largest forging company in the world had recently announced its results for the first quarter of FY06. While the topline growth has been robust owing to strong grow across geographies, margins have contracted due to higher raw material costs. A higher other income component has further led to the bottomline outperforming the growth in topline.

(Rs m) 1QFY05 1QFY06 Change
Net sales 2,568 3,635 41.6%
Expenditure 1,878 2,750 46.4%
Operating profit (EBDITA) 690 885 28.3%
Operating profit margin (%) 26.9% 24.4%  
Other income 42 112 166.0%
Interest 79 112 41.3%
Depreciation 123 149 21.5%
Profit before tax 530 736 38.8%
Extraordinary items - - -
Tax 190 247 29.9%
Profit after tax/(loss) 340 489 43.9%
Net profit margin (%) 13.2% 13.5%  
No. of shares (m) 188.5 188.5  
Diluted earnings per share (Rs)* 7.2 10.4  
P/E (x)   30.4  
(* annualised)      

Company background
Bharat Forge is a global player in the auto ancillary sector, focusing primarily on the manufacturing of forgings for automotive manufacturers. Apart from catering to the automobile-forging segment, it also has products catering to drilling equipments used in the oil and gas sector. Exports accounted for 39% of revenues in FY05. Recently, the company acquired Federal Forge Inc in the US, which is engaged in designing and manufacturing of complex forged steel components in the US, with primary focus on the passenger car and LCV segment.

What has driven growth in 1QFY06?
Momentum maintained at the top(line):  Bharat Forge has benefited from the strong demand growth in the auto industry. What is more heartening to note is that the company has consistently been able to outperform the auto industry growth. To put things in perspective, in 1QFY06, the passenger car industry registered a 17% YoY growth and commercial vehicle demand increased by 6% YoY. As against this, the company managed to achieve a 30% YoY growth in the domestic sales primarily on account of two reasons. First being the ramp up of the production capacity, which enabled Bharat Forge to reduce the impact of production constraints and, secondly, increased share of business with domestic customers in technologically advanced products.

On the exports front, the company has performed even better, which is evident from increased share of exports to total revenue (see table below) led by sales to European countries. This has been partly because of the couple of acquisitions that it made in Europe in 2004. It should be noted the export figures do not include the sales of these subsidiaries.

Geographical breakup…
Markets 1QFY05 1QFY06 % Change
USA 462 679 47.0%
% exports 48.4% 43.8%  
Europe 273 500 83.2%
% exports 28.6% 32.2%  
Asia pacific 219 372 69.9%
% exports 23.0% 24.0%  
Total 954 1551 62.6%
% total sales 37.1% 42.7%  

Higher input costs dent margins:  In spite of a splendid topline growth, the operating margins failed to maintain the pace primarily because of rising input costs (see table below). Staff costs have also increased as a percent of sale and this was primarily due to increase in staff strength ahead of the expansion plans coming into effect. Similarly, during the quarter, the company has also made recruitments in line with is global plans. Going forward, we believe that the softening of steel prices coupled with thrust on higher value added product sales would provide adequate room for improving the margins.

Cost break-up…
(Rs m) 1QFY05 1QFY06 Change
Raw materials 1,003 1,692 68.7%
% sales 39.1% 46.5%  
Manufacturing expenses 437 580 32.7%
% sales 17.0% 16.0%  
Staff cost 158 231 46.1%
% sales 6.2% 6.4%  
Other expenses 280 301 7.4%
% sales 10.9% 8.3%  

It flows to the bottom(line):  During the quarter, the company has raised fund through FCCB issue of US$ 100 m to meet its expansion plans. Pending utilisation of these funds, they are deployed in investments, which has generated an income of Rs 72 m that has consequently helped a strong rise in net profits.

What to expect?
At the current price of Rs 315, the stock is trading at price to earnings multiple of 30.4 times its annualised 1QFY06 earnings. As we go forward, since margins in the overseas markets are comparatively on the lower side as compared to the domestic markets, overall margin growth will be limited. Further, with the company’s foray in the passenger car market, we expect the margins to be under pressure.

On the positive side, the company will almost double its forging capacity and will substantially enhance its component machining capacity. Further, as per the management, the additional capacity is already sold out. With steel prices displaying signs of cooling off, benefits of economies of scale kicking in and the management’s thrust on accessing high end of the value products, this could enable the company to pare the pressure on margins. With the company’s continuous thrust on expanding the geographical reach and a strong move towards outsourcing, we believe that growth is unlikely to be an issue in the next two to three years.

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