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Bharat Forge (BHFC)
Automobiles
Exports and non-auto business in good shape. Bharat Forge’s automotive exports
and non-auto business is growing at a fast clip driven by strong growth in commercial
vehicles in US and Europe due to replacement demand and increase in customer
penetration/acquisition in the non-auto business. We maintain our ADD rating with a
target price of Rs320 (unchanged) based on the sum-of-the-parts valuation
methodology.
US and EU commercial vehicle volumes growing at a robust pace
US class 8 trucks and EU heavy truck volumes have been growing at a robust pace despite concerns
of a slowdown in these geographies. US class 8 truck volumes grew by 58% yoy during January-
August 2011 while European heavy truck volumes rose by 31% yoy during January-June 2011
driven by strong replacement demand. Heavy truck volumes in these geographies have declined by
40-60% from peak levels since the Lehman crisis. We factor in 21% and 12% yoy growth in auto
exports to US and EU in FY2012E and FY2013E, respectively. We believe a slowdown in economic
growth in these geographies will impact commercial vehicle sales, but commercial vehicle volumes
could still grow in double digits in FY2013E driven by replacement demand. We also expect
depreciation of Rupee versus US Dollar and Euro to be EPS neutral for Bharat Forge as the company
has hedged 70% of its export exposure.
Non-auto revenues likely to grow at a steady rate
We forecast non-auto exports to grow by 19% yoy in FY2012E and 13% yoy in FY2013E, which is
significantly below the management guidance. Oil and gas drilling, power and construction/mining
segments are the three key growth areas for Bharat Forge. Bharat Forge’s strategy revolves around
increasing penetration of more products in the non-auto space with existing customers and adding
new customers. Bharat Forge’s non-auto business has grown by 29% yoy in 1QFY12 and the
company plans to add machining capacities backed by its customer orders, which will start
contributing to the company’s revenues from 3QFY12E. Oil and gas drilling forms the largest pie in
the non-auto business and we believe this segment is unlikely to see a major slowdown due to
increase in exploration activities in US to meet future energy needs.
We maintain our ADD rating on the stock
We believe the stock is trading at attractive levels post the correction (7X EV/EBITDA on our
consolidated FY2013E forecast). The stock trades at 22% discount to its historical valuation and we
believe given the strong earnings growth over the next two years, the stock could re-rate from
current levels. Our SOTP-based target price is Rs320. We have not made any change to our
earnings estimates.
Exports and non-auto business keeping up pace
We maintain our ADD rating on Bharat Forge as we believe the business is expected to grow
at a robust pace backed by strong growth in the exports and non-auto segment. Our target
price of Rs320 implies a 19% return from current levels. Our target price is based on the
sum-of-the-parts valuation methodology. We value the standalone business at 8X EV/EBITDA
and subsidiary business at 4X EV/EBITDA to arrive at our target price. We have not made any
change to our earnings estimates.
The stock has corrected due to concerns on the European debt crises and slowing growth in
the US economy could impact Bharat Forge’s revenues. 49% of the consolidated revenues
come from Europe and US. We try to address some concerns of investors in this note.
(1) US class 8 trucks and EU heavy truck volumes have been growing at a robust pace
despite concerns of a slowdown in these geographies. US class 8 truck volumes
grew by 58% yoy during January-August 2011 while European heavy truck
volumes rose by 31% yoy during January-June 2011 driven by strong replacement
demand. Heavy truck volumes in these geographies have declined by 40-60% from
peak levels since the Lehman crisis. We factor in 21% yoy and 12% yoy growth in
auto exports to US and EU in FY2012E and FY2013E, respectively.
(2) We forecast non-auto exports to grow by 19% yoy in FY2012E and 13% yoy in
FY2013E, which is significantly below the management guidance. Oil and gas
drilling, power and construction/mining segments are three key growth areas for
Bharat Forge. Bharat Forge’s strategy revolves around increasing penetration of
more products in the non-auto space with existing customers and adding new
customers. Bharat Forge’s non-auto business has grown by 29% yoy in 1QFY12
and the company plans to add machining capacities backed by its customer orders,
which will start contributing to the company’s revenues from 3QFY12E. Oil and gas
drilling forms the largest pie in the non-auto business and we believe this segment
is unlikely to see a major slowdown due to increase in exploration activities in US to
meet future energy needs.
(3) We forecast subsidiaries to break even in FY2012E and FY2013E and have not
forecasted any contribution from the subsidiaries in the consolidated profits for the
next two years. Subsidiaries are operating at 55% capacity utilization and the
break-even utilization is close to 40% levels, according to the management. We
believe subsidiaries are unlikely to report losses over the next two years because of
restructuring actions taken by the management in the past two years.
(4) The company plans to increase machining capacities by 30% over the next few
years. This is a higher-margin business and could be a key driver for improvement in
EBITDA margins, in our view. We forecast EBITDA margins to improve by 50 bps
over the next two years due to improvement in product mix.
We believe the stock is trading at attractive levels post the correction (7X EV/EBITDA on our
consolidated FY2013E forecast). The stock trades at 22% discount to its historical valuation
and we believe given the strong earnings growth over the next two years, the stock could
re-rate from current levels.
Sensitivity to currency fluctuations: No major impact
The Rupee has depreciated by 3% and 11% versus US Dollar and Euro, respectively since
June 2011. We highlight the currency sensitivity to Bharat Forge’s earnings below. Bharat
Forge could have been a net beneficiary of the depreciation of Rupee versus Dollar and Euro
as exports from India to these geographies exceed the foreign debt on its balance sheet.
However, the company had hedged 70% of its export exposure in FY2011 and left a major
part of its foreign debt unhedged. We are not factoring in any profits from subsidiaries;
hence, net currency impact due to exposure in subsidiaries will be minimal as costs as well as
revenues are in respective currencies.
Bharat Forge has FCCBs worth US$80 mn outstanding on its balance sheet which are out of
the money and are due to be redeemed on April 18, 2012 (worth US$40mn, conversion
price – Rs604/share) and on April 18, 2013 (worth US$39.9 mn, conversion price –
Rs690.3/share). The company will need to pay 143% and 157% of the FCCB amount if the
bond is not converted in the exercise period. If both bonds are not converted, the company
will need to pay Rs760 mn and Rs1,006 mn, respectively to bondholders in April 2012 and
April 2013.
If the Rupee depreciates by 5% against Dollar and Euro, we estimate consolidated earnings
will increase by 6% after taking the impact due to translation losses on the foreign debt if
the exposure is completely unhedged. However, the company had hedged 70% of its
currency exposure in FY2011 and it may have taken similar hedges in FY2012E as well.
Hence, impact on earnings will be minimal due to forward hedges taken on exports.
