Accumulate Bharat Forge – 3QFY2011 Result Update - Angel Broking

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Bharat Forge – 3QFY2011 Result Update

Angel Broking recommends an Accumulate on Bharat Forge with a Target Price of Rs. 404.

Consolidated performance above expectations: For 3QFY2011, Bharat Forge

(BFL) posted 50.2% yoy top-line growth to `1,235.3cr, above our expectation of

`1,178.5cr and largely aided by the substantial jump in domestic operations.

EBITDA margins came in 32bp above our estimates at 18.1%, a jump of 151bp

yoy. Net profit grew strongly by 190.5% yoy (on a low base of last year) to

`73.3cr (`25.2cr in 3QFY2010), as against our estimate of `67cr, largely aided

by improved operating performance

Standalone performance: BFL posted a 53.1% yoy jump in standalone revenue to

`777cr, largely aided by a ~35% jump in domestic revenue and around ~81%

jump in exports. EBITDA margin on a standalone basis remained at 2QFY2011

level and grew by 86bp yoy to 24.3%, despite a surge in steel prices. BFL posted

a 117.5% yoy jump in net profit to `82.6cr, beating our estimate of `68.1cr,

owing to better performance at the operating level and higher other income.

Outlook and valuation: On the valuation front, at `358, the stock is trading at a

P/E of 17.7x FY2012E EPS and EV/EBITDA of 10.1x on a consolidated basis. We

remain positive on BFL and recommend an Accumulate rating to the stock to play

the turnaround of developed markets (US and Europe). At our Target Price of

`404, the stock would trade at 20x P/E and 11.3x EV/EBITDA on FY2012E basis.

Top line above expectations, exceeds estimates by 5.2%: BFL reported a 53.1%

yoy jump in standalone revenue to `777cr, largely aided by a ~35% jump in

domestic revenue and around ~81% jump in exports. Domestic market growth

was aided by substantial growth in overall auto volumes, especially in the CV

segment. On the exports front, as per management, volumes (particularly in

the US) recorded an improvement in 1HFY2011, which continued in

3QFY2011. At present, BFL is operating at an optimum utilisation level, which

is expected to improve going forward. Volume in tonnage terms increased by

~35.9% yoy and ~4.3% qoq to 48,116mt (35,410mt in 3QFY2010), while

average net realisation moved up by around ~12% yoy and ~3.3% qoq.

Improved operating leverage helps margin expansion: BFL’s operating margins

increased by 86bp yoy to 24.3% during 3QFY2011. This is despite a surge in

raw-material costs, which increased by 147bp yoy and accounted for 46.9%

(45.5% in 3QFY2010) of net sales (largely because of a surge in steel prices). The

company achieved better operating leverage, following the reduction in staff costs

and other expenditure to the extent of 65bp and 56bp yoy, respectively. Thus,

overall, the company recorded a 58.7% yoy jump in operating profit to `188.6cr

on a standalone basis.

Net profit at `82.6cr, beats estimates: BFL recorded net profit of `82.6cr (`38cr)

during the quarter due to overall improvement in volumes and operating leverage.

Higher other income also aided better growth in net profit, to a certain extent,

during the quarter. However, interest cost and depreciation cost increased by 13%

yoy and 21.3% yoy, respectively, for the quarter.

Consolidated performance exceeds expectation: BFL reported 50.2% yoy growth in

its top line to `1,235cr, which was above our expectation of `1,179cr and largely

aided by the substantial jump in domestic operations. BFL’s EBITDA margins for

3QFY2011 came in 32bp above our estimate at 18.1%, a jump of 151bp yoy on

improved operating leverage in both domestic and overseas operations. The

company reported a 190.5% yoy jump (on low base of last year) in net profit to

`73.3cr (`25.2cr in 3QFY2010), as against our estimate of `67cr, largely aided by

improved operating performance.

Conference call – Key highlights

􀂄 International operations: BFL’s international operations continued to grow

during the quarter (contributing ~46% to its standalone revenue), driven by

recovery in offtake from both US and European markets. US and Europe

contributed ~22% and ~20% to the company’s standalone revenue,

respectively, during 3QFY2011. Exports to US grew by 31.9% yoy and that to

Europe increased by 147.6% yoy during the quarter. Utilisation levels on the

international front remained at 55–60%. Going ahead, on the back of

improved operating leverage, management expects expansion in margins. BFL

has added new clients in South America and China and has increased its

market share in the engine component side of the business.

􀂄 Non-auto business: BFL’s non-auto business revenue stood at ~`287cr during

3QFY2011. Revenue contribution from the three non-auto facilities stood at

~`125cr during the quarter. Utilisation level remained at 35–40% in

3QFY2011. Management intends to ramp it up further to 50% by the end of

FY2011. BFL is targeting ~40% of its total revenue from the non-auto business

by FY2012, which is currently ~37%. Management remains optimistic on the

power side of the business and its JV with Alstom; revenue contribution is

expected to begin from FY2012. Further, work on the EPC contract worth

`1,800cr bagged during 1QFY2011 is expected to commence soon.

􀂄 BFL intends to incur a capital expenditure of `100cr–`120crcr during FY2011E

and FY2012E for Indian operations and has no plans to incur any capital

expenditure overseas. As of September 2011, the company reported net debt

of ~`1,080cr.

􀂄 BFL intends to increase the machining capacity at its Baramati plant by 30% as

it is seeing strong demand from domestic as well as exports markets.

􀂄 The company incurred restructuring cost of `81mn, which includes one-time

cost (`50mn) incurred for union negotiation settlement in Bharat Forge

America to achieve concessions and expenses (`31cr) on transfer of business

from Bharat Forge Scottish Stampings Ltd.

􀂄 Out of the total exports, ~64% was from the auto business and rest was from

the non-auto business.

Investment arguments

􀂄 Strong rebound in domestic operations continues on healthy CV demand: BFL,

being a market leader in the CV space for products such as crankshaft, axle

beams and connecting rods, with almost a 90% market share, has been able

to register robust growth sequentially. Over the last few quarters, following the

overall recovery in economic and industrial activity, CV volumes have also

been showing good recovery. We estimate the domestic heavy CV segment to

record a ~13% CAGR over FY2010–12E. Thus, BFL is expected to be one of

the biggest beneficiaries on the anticipated higher offtake by the CV segment

over the next couple of years.

􀂄 Rebound in global economy to help in turnaround of overseas operations: BFL

experienced tough times in the overseas market, especially in the US and

Europe in the last two years. Management had adopted various measures to

counter the effects of the downturn, such as rightsizing the company’s

operations globally to adjust to lower demand levels. Other actions taken

included reduction of manpower, rationalisation of production, salary cuts,

reduction in administrative overheads, increased focus on working capital

reduction, conservation of cash and capex holiday in FY2010. The company

also focused on improving its operational efficiencies such as yield, scrap

reduction, energy cost and outsourcing reduction.

All these measures have helped BFL in bringing down its breakeven levels to

almost 50% utilisation (60–65% earlier). We believe most of these markets are

now showing signs of recovery, which would help the company to improve its

consolidated performance over FY2010–12E.

􀂄 Non-auto diversification: BFL has been diversifying its product portfolio in the

non-auto segment. Though the company has order traction in this segment (oil

and gas, power–thermal and nuclear, and rail), the lower level of its clients’

business in various industries has affected potential ramp-up of utilisation

levels of new capacities created especially for the segment. Around 60% of the

segment’s revenue comes from exports, while the balance comes from the

domestic market. The company expects to generate ~40% of its revenue from

this segment in FY2011E on total incurred capex of around `500cr.

Management is confident of growing its non-auto business faster, which would

act as a buffer to the prevailing difficult macro environment for its auto

business.

Further, BFL has entered into a JV with Alstom and NTPC to manufacture

state-of-the-art supercritical power plant equipment in India. The JV will

design, engineer, manufacture and deliver turbine generator islands of

600–800MW supercritical range, with total installed capacity of 5,000MW per

year. Alstom and BFL have agreed to explore the manufacture of turbines and

generators in the subcritical range, as well as for gas and nuclear

applications

The manufacturing infrastructure will include plants for manufacturing

turbines, generators and all the auxiliaries that go into turbine generator

islands. The JV entails an investment of `1,500cr from both the partners. BFL

is expected to invest around `300cr–350cr in the Alstom JV over the next three

years. The capacity is set to be commissioned in 2012. BFL’s equity

contribution in the NTPC JV would be `50cr over the next two years. The

company has also bagged its maiden order worth `2,000cr in the capital

goods space for an EPC contract. This JV will help the company show healthy

performance at consolidated levels.

Outlook and valuation

A substantial portion of BFL’s revenue comes from the CV segment, where recovery

has been recorded in its mid-cycle. Moreover, a major portion of the company’s

consolidated revenue comes from the US, which was in the recessionary mode and

is expected to come out of it in 2010. BFL’s non-auto business has also started

contributing more from FY2011 and mitigates the effects of the slowdown in the

auto segment. We broadly maintain our revenue and earnings estimates for the

company.

On the valuation front, at `358, the stock is trading at a P/E of 17.7x FY2012E EPS

and EV/EBITDA of 10.1x on a consolidated basis. We remain positive on BFL and

recommend an Accumulate rating to the stock to play the turnaround of developed

markets (US and Europe). At our Target Price of `404, the stock would trade at

20x P/E and 11.3x EV/EBITDA on FY2012E basis.