Bharat Forge (CMP: Rs293) Outperformer

We recently met the management of Bharat Forge (BFL) to get an update on its existing businesses as well as on some new initiatives and expansion plans announced by the company. On the existing business front, BFL has gained market share with Tata Motors – a key customer due to favorable change in Tata Motors’ product mix. This, and a strong growth in the non-automotive components business have mitigated the impact of a slowdown in CV sales in FY08.
Growth in exports too has been strong at 30%yoy (42%yoy adjusted for rupee appreciation) during 9mth FY08. Amongst BFL’s overseas subsidiaries, BFL America has seen a significant drop in business volumes in FY08 due to a slowdown in car and truck sales in North America.
On the new initiatives front, BFL’s upcoming non-automotive components facilities are likely to commence commercial operations in Q4FY09 and we expect material revenue contribution only from Q1FY10. These facilities are likely to operate at ~50% capacity utilization in FY10 and would have a revenue potential of Rs9-10bn at 100% utilization. BFL’s proposed JV with NTPC (51:49) would initially manufacture components for power equipment and would aim at manufacturing complete power plants by 2011-12 (initial capacity likely to 4500MW). Though BFL’s stake in the JV could be in for a significant dilution due to induction of a technology partner, it would remain a key component supplier to the JV with the obvious benefits of enhanced business opportunities.
BFL’s proposed Rs7.0bn fund raising plans (Rs4.0bn in debt and Rs3.0bn in preferential warrant issue to promoters) would be utilized for funding the proposed venture into the Capital Goods sector (which includes the JV with NTPC). We believe BFL would also need to plan a further expansion in its automotive components business as we estimate ~100% capacity utilization in this segment by FY10.

In our view the company’s target of 12% EBIDTA margin for its subsidiaries by FY10 (7.9% in 9mth FY08) appears stretched due to delays in achieving benefits of product rationalization and other synergies. BFL has re-iterated that escalations in steel prices are a pass through with most customers and hence would not impact margins materially. Going forward, we expect higher proportion of non-automotive components to lead to higher margins and consequently expect ~300bps margin expansion over FY08-10. This would lead to a strong 40% PAT CAGR for BFL over FY08-10. The stock trades at PER of 13.3x and EV/EBIDTA of 6.2x FY10 based on fully diluted equity capital. Maintain Outperformer.