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Bharat Forge: Awaiting the next phase! - Views on News from Equitymaster
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Bharat Forge: Awaiting the next phase!
Oct 17, 2006

Performance Summary
Bharat Forge, world’s second largest forging company has reported a decent set a numbers for 2QFY07. During the quarter, while the topline growth has come in at 20%, the bottomline has also grown by the same rate. Operating margins however, have expanded marginally by 30 basis points.

As far as consolidated numbers are concerned, the company has experienced pressure as despite the 41% growth in topline, the bottomline has grown at a much lower 21%. Operating margins have also suffered a decline of 230 basis points. These numbers however should be viewed in the context of a company, which is undergoing a major metamorphosis, both organically as well as inorganically and thus lending itself to significant scope for improvement.

Financial performance: Standalone snapshot
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Net sales 3,766 4,507 19.7% 7,401 8,713 17.7%
Expenditure 2,795 3,330 19.2% 5,545 6,519 17.6%
Operating profit (EBDITA) 971 1,177 21.1% 1,857 2,194 18.2%
EBDITA margin (%) 25.8% 26.1%   25.1% 25.2%  
Other income 115 192 67.6% 226 425 87.6%
Interest (net) 128 197 53.5% 240 372 55.3%
Depreciation 175 250 42.3% 325 478 47.3%
Profit before tax 783 922 17.9% 1,518 1,768 16.4%
Extraordinary income/(expense) - -   - (45)  
Tax 265 301 13.5% 512 586 14.5%
Profit after tax/(loss) 518 622 20.1% 1,007 1,137 12.9%
Net profit margin (%) 13.7% 13.8%   13.6% 13.1%  
No. of shares (m) 216.0 222.7   216.0 222.7  
Diluted earnings per share (Rs)* 9.3 11.2   9.0 20.4  
Price to earnings ratio (x)**         36.5  
(* annualised, ** on trailing twelve months earnings)

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, in 1QFY06, Federal Forge of US was acquired and in the same fiscal, it acquired Imatra Kilsta of Sweden). With CDP and Aluminiumtechnik and now Imatra Kilsta in its kitty, it has gained a strong foothold in Europe.

Consolidated results
(Rs m) 2QFY06 2QFY07 change
Net sales 6,866 9,709 41.4%
Expenditure 5,566 8,101 45.5%
Operating profit (EBDITA) 1,300 1,607 23.7%
EBDITA margin (%) 18.9% 16.6%  
Other income 115 193 68.2%
Interest (net) 160 233 45.6%
Depreciation 288 450 56.0%
Profit before tax 966 1,118 15.7%
Extraordinary income/(expense) - -  
Tax 355 375 5.8%
Profit after tax/(loss) 612 742 21.4%
Net profit margin (%) 8.9% 7.6%  
No. of shares (m) 216.0 222.7  
Diluted earnings per share (Rs)* 11.0 13.3  
Price to earnings ratio (x)**   30.6  
(* annualised, ** on trailing twelve months earnings)

What has driven performance in 2QFY07?
‘Conducive environment + proactive approach = Consistent growth’: Both the domestic as well as exports market have contributed in equal measure towards the 20% YoY growth in topline during 2QFY07. The domestic segment grew by 18% and contributed 62% to the topline. Exports on the other hand, grew by 23% YoY and contributed the remaining 38% to the total sales. While the conducive domestic environment (robust growth in all automotive segments continued unabated) resulted in an inflated domestic order book, company’s strategy of de-risking its exports, both geographically as well as in terms of product offerings helped register strong growth in exports.

It should be remembered that from being predominantly a CV chassis supplier to the US market, the company has now become a supplier of both engine as well as chassis components to not only the CV but also the passenger car industry. Also in terms of geographical split, while the US accounted for 67% of its exports in FY03, the figure has come down to 21% in FY06. Thus the consistent growth in exports is a testament to the company’s efforts at significantly de-risking its business model.

Cost break up
(Rs m) 2QFY06 2QFY07 Change
Raw materials 1,689 1,938 14.8%
% sales 44.8% 43.0%  
Staff cost 227 276 22.0%
% sales 6.0% 6.1%  
Manufacturing expenses 622 813 30.6%
% sales 16.5% 18.0%  
Other expenditure 257 303 17.8%
% sales 6.8% 6.7%  

High value add products aid margin expansion: Operating margins of the company during the quarter have recorded a marginal improvement of 30 basis points. This has to be viewed on the back of progressive ramp up in forging capacity, superior product mix with higher proportion of machined components and ramp up of value added heavy duty engine part components. We view the current set of operating margins as rather sustainable as the company moves towards its stated ambition of becoming an end-to-end supplier by collaborating with the OEMs right from design and development stage to the shipping of components. Such a relationship calls for much improved bargaining power in the hands of suppliers and consequently, even higher margins.

On the consolidated level however, margins have fallen by 230 basis points. We view this as a rather temporary phase since with further integration of its subsidiaries with itself; margins should improve from the current levels.

Among other expenses, depreciation outgo continues to remain high on account of the recent capacity expansion plan of the company. The effect should however recede once the company starts utilizing more of its expanded capacity and enables the operating leverage to kick in. While the net interest cost has also risen by 54%, interest coverage remains at a rather manageable 4.7 times pre interest earnings.

What to expect?
At the current price of Rs 362, the stock is trading at a rather ‘Infosys’que price to earnings multiple of 37 times its standalone and 31 times its consolidated trailing twelve month earnings. If one looks at the long-term plans of the company, the current valuations do not look out of sync with the fundamentals of the company. Bharat Forge has lined up investments to cater to the high margin non-automotive forgings segments like hydrocarbon, energy and aerospace. Besides, its efforts at moving up the value chain in automotive forgings are also a big positive. Thus there seems to adequate visibility to make us fell upbeat about the long-term prospects of the company.

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