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Bharat Forge: Expansion starting to reflect
Oct 18, 2005

Performance summary
Bharat Forge, one of the leading manufacturers of forgings in India and also a global supplier to many auto manufacturers, announced its results today. While standalone sales grew at a brisk rate of 30% YoY in 2QFY06, net profit growth was higher at 37% YoY. On a consolidated basis, net income grew by 45% YoY in the quarter. The company's expansion plans are in the final stages and to that extent, the growth numbers will be higher going forward, in line with the increased capacity utilisation.

(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Net sales 2,902 3,766 29.8% 5,469 7,401 35.3%
Expenditure 2,091 2,795 33.7% 3,969 5,545 39.7%
Operating profit (EBDITA) 811 971 19.8% 1,500 1,857 23.8%
EBDITA margin (%) 27.9% 25.8%   27.4% 25.1%  
Other income 7 115 1537.1% 49 226 361.8%
Interest (net) 83 128 54.3% 162 240 48.0%
Depreciation 132 175 32.9% 255 325 27.4%
Profit before tax 603 783 29.8% 1,132 1,518 34.1%
Tax 225 265 17.7% 415 512 23.3%
Profit after tax/(loss) 378 518 37.0% 717 1,007 40.4%
Net profit margin (%) 13.0% 13.7%   13.1% 13.6%  
No. of shares (m) 188.5 188.5   188.5 188.5  
Diluted earnings per share (Rs)* 8.0 11.0   7.6 10.7  
Price to earnings ratio - standalone (x)   30.0     30.9  
Price to earnings ratio - consolidated (x)   25.4     NA  
(* annualised)            

What is the company's business?
Bharat Forge (BFRG) is the second largest forging company in the world with an installed capacity of 130,000 tonnes in FY05. It is the largest exporter of auto components from India and leading chassis component manufacturer in the world (Source: Company). BFRG manufacturers a wide range of critical components for passenger cars, commercial vehicles and diesel engines. On the domestic front, the company's list of clients includes Tata Motors, Ashok Leyland, Eicher, M&M, Toyota and Maruti Udyog. On the international front, the client lists consists of Volvo, Caterpillar, Toyota, Renault and Daimler Chrysler, to name a few. The company is in a major capacity expansion phase (expected to be completed in 2005-06), which would increase its passenger car crankshaft capacity to approximately 650,000 numbers per year and increase its forging capacity to 240,000 tonnes. Further, it is also expanding its capacity of front axle beams to 1 m units.

What has driven performance in 2QFY06?
Exports grow above 35%: During the second quarter, while the company's domestic revenues grew by 27% YoY, exports grew at a faster clip of 36% YoY in 2QFY06 thus propelling the overall topline growth to 30% YoY. Export contribution to overall sales in 2QFY06 increased to 37% (for the first half, it is at 38%). We believe that the company's expansion plans (incurred Rs 4.7 bn as capital expenditure till September 2005) is likely to shift the topline growth to a new trajectory going forward. Overall, on a standalone basis, we believe that the company's performance in 1HFY06 is in line with our full year estimates and we do not foresee any significant changes going forward.

Cost break-up...
(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Raw materials 1,336 1,766 32.2% 2,481 3,458 39.4%
% sales 46.0% 46.9%   45.4% 46.7%  
Manufacturing cost 450 622 38.4% 873 1,202 37.7%
% sales 15.5% 16.5%   16.0% 16.2%  
Staff cost 173 227 31.2% 331 458 38.4%
% sales 6.0% 6.0%   6.0% 6.2%  
Other expenses 239 257 7.7% 532 558 4.8%
% sales 8.2% 6.8%   9.7% 7.5%  
Change in stock (106) (78) -26.8% (248) (131) -47.3%
% sales -3.7% -2.1%   -4.5% -1.8%  

Expansion costs subdue margins: Looking at the expense heads, while raw material costs as a percentage of sales have increased in 2QFY06 (and in 1HFY06), manufacturing costs have increased at a faster pace as compared to the topline growth. This has subdued EBDITA margins in 2QFY06. However, we believe that margins are likely to be stronger in the second half and beyond. As capacity utilisation increases, we believe that the fixed cost will spread over a wider base and therefore, as a percentage of sales, there will be a decline. Our operating margin estimate for FY06 stands at 25.2% and the company's 1HFY06 margins at 25.1% are in line. If one considers the trend in EBDITA margin over the last few quarters, given the fall in steel prices globally, there has been an improvement. If steel prices soften further, margins will improve (we have factored in around 0.5% decline in raw material cost to sales post FY06).

Issue proceeds boost other income: Other income has risen at a faster pace in 2QFY06 owing to additional interest income on proceeds from GDR issue (89% and 78% of other income in 2QFY06 and 1HFY06 respectively). We expect other income to increase further in 2HFY06, owing to the same reason. The rise in interest expense has to be viewed in the context of outgo towards money raised through foreign currency borrowings. Since the company is in the midst of an expansion programme, higher depreciation charges were also expected. Overall, we believe that the company's performance in 1HFY06 is commendable.

What to expect?
The stock currently trades at Rs 330, implying a price to earnings multiple of 22.1 times our estimated FY06 earnings. Overall, we maintain our HOLD view on the stock from a two to three year perspective. We have exercised caution as far as our assumptions of the consolidated financials are concerned and to that extent, there is an upside to our estimates.

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