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Bharat Forge: Diversification is working
Oct 29, 2007

Performance Summary
  • Standalone sales grow 25% YoY, courtesy a strong 41% YoY growth in exports.

  • Pressure on costs has led to the operating margins eroding by 150 basis points (1.5%).

  • Bottomline growth remains modest at 9% YoY, as higher interest expenses and depreciation charges take toll.

  • Consolidated bottomline grows by 7% YoY, slightly lower than the 8% YoY growth in topline. Operating margins though, show an improvement of 40 basis points (0.4%).

Financial performance: Standalone snapshot
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Net sales 4,507 5,632 25.0% 8,713 10,601 21.7%
Expenditure 3,330 4,249 27.6% 6,519 8,206 25.9%
Operating profit (EBDITA) 1,177 1,383 17.5% 2,194 2,395 9.2%
EBDITA margin (%) 26.1% 24.6%   25.2% 22.6%  
Other income 192 253 31.5% 425 786 85.1%
Interest (net) 197 273 38.9% 372 507 36.1%
Depreciation 250 351 40.7% 478 680 42.1%
Profit before tax 922 1,012 9.7% 1,768 1,995 12.8%
Extraordinary income/(expense) - -   (68)    
Tax 301 334 11.1% 563 669 18.8%
Profit after tax/(loss) 622 677 8.9% 1,137 1,326 16.6%
Net profit margin (%) 13.8% 12.0%   13.1% 12.5%  
No. of shares (m) 222.7 222.7   222.7 222.7  
Diluted earnings per share (Rs)*         11.6  
Price to earnings ratio (x)*         30.4  
(* 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 340,000 tonnes. 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. With CDP and Aluminiumtechnik in its kitty, it has gained a strong foothold in Europe

What has driven performance in 2QFY08?
Exports once again drive the topline: The 25% YoY growth in topline during the quarter was once again led by the 41% YoY growth in exports, which improved its share in total revenues from 38% in 2QFY07 to 43% in 2QFY08. That the company was able to achieve this growth despite the rising rupee was indeed commendable. Excluding the impact of the same, exports have grown at a stellar 54% YoY. The company’s improved performance on the exports front has come on the back of strong demand from Europe and Asia Pacific, which now constitutes roughly 50% of the exports and a successful ramp up in production of heavy duty engine parts and passenger car engine components for the US and European market.

Domestic sales however, grew at a lower rate of 14% YoY, and quite understandably so, since the domestic auto industry, especially the CV industry, which is the key driver of the company’s revenues, remained subdued during 2QFY08. However, since Bharat Forge’s business model is now quite adequately diversified, both in terms of product segment as well as geographies, the impact on the overall standalone topline was rather limited. With the company now planning to enter the non-automotive forgings segment, the influence that the domestic auto industry exerts on the company’s fortunes will further reduce. On the consolidated front, topline has grown by a much lesser 8% YoY, due largely to the mature nature of almost all its overseas businesses and also the fact that operations, mainly in Europe remained shut for a substantial period during the quarter owing to the annual holiday season.

Rising rupee hurts margins: Operating margins, like the previous sequential quarter, have fallen by 160 basis points (1.6%) and in the process, have somewhat dampened the buoyant topline growth. This is because while a substantial portion of the company’s revenues was recorded in dollars and euros, all its costs were incurred in rupees. Thus, with the rupee appreciating considerably vis-ŕ-vis the greenback, margins have taken a hit. Operating margins however, improved for the consolidated operations, edging higher by 40 basis points.

cost break up
(Rs m) 2QFY07 2QFY08 Change
Raw materials 1,938 2,548 31.5%
% sales 43.0% 45.2%  
Staff cost 276 354 28.0%
% sales 6.1% 6.3%  
Manufacturing expenses 813 934 14.9%
% sales 18.0% 16.6%  
Other expenditure 303 414 36.4%
% sales 6.7% 7.3%  

Interest expenses and depreciation charges have gone up substantially during the quarter and this has pulled down the standalone bottomline growth to 9% YoY. Since the company follows the policy of natural hedging i.e., offsetting dollar based earnings by dollar based financing, the other income has grown by an impressive 32% YoY due mainly to higher earnings on foreign currency borrowings and bank deposits. These have helped the company balance out some of the negative impact of higher interest and depreciation charges, and enable it to earn a modest 9% growth in standalone bottomline during the quarter. The effect of this higher other income has been even more prominent in the first half period, where bottomline growth has stood at 17% YoY on the back of a 22% growth in topline. Here while operating profits have improved by a small 9% YoY, it is the 85% YoY jump in other income that has helped net profits to grow 17% YoY.

consolidated financials
(Rs m) 2QFY07 2QFY08 change
Net sales 9,709 10,452 7.7%
Expenditure 8,101 8,676 7.1%
Operating profit (EBDITA) 1,607 1,776 10.5%
EBDITA margin (%) 16.6% 17.0%  
Other income 193 261 35.1%
Interest (net) 233 300 28.9%
Depreciation 450 543 20.7%
Profit before tax 1,118 1,193 6.8%
Extraordinary income/(expense) - -  
Tax 375 402 7.1%
Profit after tax/(loss) 742 791 6.6%
Net profit margin (%) 7.6% 7.6%  
No. of shares (m) 222.7 222.7  
Diluted earnings per share (Rs)* 13.3 14.2  
Price to earnings ratio (x)**   26.1  
(* annualised, ** on trailing twelve months earnings)

What to expect?
At the current price of Rs 353, the stock is trading at a multiple of 13 times our estimated FY10 earnings. While the current valuation levels may be steep, the company’s expansion plans, especially in the non-automotive forgings space will give its earnings a big boost in the medium term. Given Bharat Forge’s strong execution skills and efforts at continuously adding value to its customers, we remain positive on the long-term prospects of the company.

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