While everyone is going hung-ho about the performance of auto majors like Telco and Hero Honda in recent years, auto ancillary firms seem to have been sidelined. However, the latter ones have also benefited in a large way from the buoyancy in automobile demand over the last two years. After restructuring operations since late 1990s, select auto ancillary majors are actually much leaner and efficient, as compared to a decade ago. Bharat Forge (BFL) is one of them.
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After demerging its investment subsidiaries, the company is solely focusing on increasing its presence in the forging business, both in the domestic and international markets. It is one of the key forging suppliers to the likes of Telco and Ashok Leyland. On the international front, BFL’s client list includes Volvo, Mitsubishi, Caterpillar, Toyota, Renault, Honda, Isuzu, Mercedes and New Holland. The international client list has been on the rise ever since the company directed its effort to increase export contribution.
BFL has recently signed an agreement with Dana Corp. of US for supply of forgings. As per this agreement, the company has taken over order book position of Danas SpicerEurope Ltd’s operation in Kirkstall, UK for Rs 210 m. BFL would supply all the clients of Kirkstall Division in the oil & gas business. Indirectly, after the order book takeover, BFL has acquired 10 new customers, consequent to which the number of global and domestic customers has touched 21. Apart from this, it had entered into an agreement with a Chinese manufacturer for supply of forgings for the next five years.
Efforts on exports front have already started reflecting in the performance. The company posted a 31% rise in revenues and managed to increase profits four-fold in 1QFY03. Focus on export markets has resulted in a 120% rise in international sales in the same period. As a result, contribution from exports has touched 34% in 1QFY03 as compared to 20% in 1QFY02. The performance in 1QFY03 however, does not include the order book supply agreement with Dana.
Operating margins have also improved notably in 1QFY03 led by higher capacity utilisation and lower raw material consumption. Employee cost savings are also one of the key reasons for the rise in operating profits (BFL had reduced its workforce by 1,300 employees in the last two years). Higher cash flow from operation that was used to repay debt and lower interest costs have resulted in a 13% fall in interest expenses during the quarter. BFL has targeted reducing debt by Rs 3,850 m over the next four year, so as to bring debt-equity ratio down to 1 time compared to 2.3 times in FY02.
But all is not rosy for the company. The fortunes of the auto ancillary sector are closely linked to those of the auto sector. Demand swings in any of the auto segments (cars, two-wheelers, commercial vehicles) have an impact on auto ancillary demand. Given the high usage of forgings in commercial vehicles, growth prospects of BFL remain challenging in the immediate term. Telco had projected CV demand to rise by 4%-5% in FY03 based on normal monsoons estimates. However, given the expected fall in agricultural output by around 5% (CMIE), freight movement may be affected. This could slower things in the coming quarters. The same is the case with US markets, where off late, all CV manufacturers are witnessing a tough demand scenario. Keeping all these factors in mind, growth could peter down in the coming quarters.
While a healthy order book position will insulate the company from the cyclicality in demand to a certain extent, revenue growth prospects are challenging. Besides, high leverage position of the company is also a cause of concern (interest coverage of just 1.9 times). Any adverse developments on the macro front could thus have a material impact on its profitability. At the current price of Rs 169, the stock trades at a P/E multiple of 12.9x 1QFY03 annualised earnings. This is on the higher-end of the spectrum considering the dependence on the auto sector. At the same time, the company is well-poised to capitalise on any upturn in the domestic and international markets, given its economies of scale and a commendable client list.
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