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Bharat Forge (BFRG.BO): Strong earnings growth but lower returns
profile; initiate with Neutral
Investment view
We initiate coverage on Bharat Forge with a Neutral rating and a 12-m
2.3X FY13E P/B-based TP of Rs250 implying 10% downside potential.
(1) One of the strongest earnings growth profile in our coverage group:
Bloomberg consensus currently expects the company to more than
double its EPS over FY11-FY13 (Rs12.15 in FY11A vs. Rs24.86 in FY13),
which implies one of the strongest earnings growth profiles in our
Indian auto and capital goods sector (Exhibits 59 and 60). Our estimates
for FY12-FY13 are 14%-18% below consensus, which still implies higher
earnings growth relative to our auto coverage group. (2) Aggressive
investment and financing profile: We believe Bharat Forge has
historically had an aggressive investment profile among similarly sized
peers in the auto and capital goods space, that has generally lead to
higher financing requirements, in our view (Exhibits 61-65). (3) Declining
cash returns performance: After the pick-up in earnings post the 2008
financial crisis, we believe that the improvement in cash returns has
been largely in line with the rest of our global auto & auto parts
coverage group (Exhibit 63). This leads us to believe that the turnaround
in earnings is so far cyclical in nature. Even on strong earnings growth,
cash returns remain in the 3rd quartile relative to global auto peers. (4)
Execution & returns hold the key to stock price performance: The
company’s valuation on P/B and EV/IC has steadily de-rated since 2003
due to the company’s aggressive investment profile and poor execution,
which lead to a structural decline in earnings, in our view. Stock price
performance over FY12-FY14 will depend on its ability to execute on
several growth drivers, and the trajectory of returns on capital.
Core growth drivers
(1) Continued turnaround at the European subsidiaries with break-even
at the PBT level in our estimate. (2) Execution and greater visibility on
projects in the NTPC/Alstom JV’s and the EPC division (Exhibit 77). (3)
Increasing share of revenue from domestic non-auto businesses from
37% in FY11E to about 50% by FY14E, in our view.
Valuation
(1) We find that the stock is trading at a premium to global auto and
capital goods peers on relative returns-based metrics. We believe this
implies that the market is factoring a turnaround in cash returns, driven
by earnings growth from the various businesses. (2) Our target price is
based on P/B vs. ROE regression, relative to the global auto and capital
goods peer group. We back our calculations with another relative
returns-based valuation methodology, namely Director’s Cut (EV/GCI vs.
CROCI/WACC) (Exhibits 68-75). (3) Given the higher volatility in earnings
relative to our coverage group, and the structural de-rating in balance
sheet multiples over the past few years, we do not rely on P/E and
EV/EBITDA for valuations.
Key risks
Higher/lower-than-expected auto demand, infrastructure investments
and performance of overseas subsidiaries
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Bharat Forge (BFRG.BO): Strong earnings growth but lower returns
profile; initiate with Neutral
Investment view
We initiate coverage on Bharat Forge with a Neutral rating and a 12-m
2.3X FY13E P/B-based TP of Rs250 implying 10% downside potential.
(1) One of the strongest earnings growth profile in our coverage group:
Bloomberg consensus currently expects the company to more than
double its EPS over FY11-FY13 (Rs12.15 in FY11A vs. Rs24.86 in FY13),
which implies one of the strongest earnings growth profiles in our
Indian auto and capital goods sector (Exhibits 59 and 60). Our estimates
for FY12-FY13 are 14%-18% below consensus, which still implies higher
earnings growth relative to our auto coverage group. (2) Aggressive
investment and financing profile: We believe Bharat Forge has
historically had an aggressive investment profile among similarly sized
peers in the auto and capital goods space, that has generally lead to
higher financing requirements, in our view (Exhibits 61-65). (3) Declining
cash returns performance: After the pick-up in earnings post the 2008
financial crisis, we believe that the improvement in cash returns has
been largely in line with the rest of our global auto & auto parts
coverage group (Exhibit 63). This leads us to believe that the turnaround
in earnings is so far cyclical in nature. Even on strong earnings growth,
cash returns remain in the 3rd quartile relative to global auto peers. (4)
Execution & returns hold the key to stock price performance: The
company’s valuation on P/B and EV/IC has steadily de-rated since 2003
due to the company’s aggressive investment profile and poor execution,
which lead to a structural decline in earnings, in our view. Stock price
performance over FY12-FY14 will depend on its ability to execute on
several growth drivers, and the trajectory of returns on capital.
Core growth drivers
(1) Continued turnaround at the European subsidiaries with break-even
at the PBT level in our estimate. (2) Execution and greater visibility on
projects in the NTPC/Alstom JV’s and the EPC division (Exhibit 77). (3)
Increasing share of revenue from domestic non-auto businesses from
37% in FY11E to about 50% by FY14E, in our view.
Valuation
(1) We find that the stock is trading at a premium to global auto and
capital goods peers on relative returns-based metrics. We believe this
implies that the market is factoring a turnaround in cash returns, driven
by earnings growth from the various businesses. (2) Our target price is
based on P/B vs. ROE regression, relative to the global auto and capital
goods peer group. We back our calculations with another relative
returns-based valuation methodology, namely Director’s Cut (EV/GCI vs.
CROCI/WACC) (Exhibits 68-75). (3) Given the higher volatility in earnings
relative to our coverage group, and the structural de-rating in balance
sheet multiples over the past few years, we do not rely on P/E and
EV/EBITDA for valuations.
Key risks
Higher/lower-than-expected auto demand, infrastructure investments
and performance of overseas subsidiaries
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