Turnaround in overseas biz, non-auto focus augur well for Bharat Forge

Bharat Forge Ltd (BFL), a global major in auto component manufacturing, is seeing a turnaround in its international operations and stands to benefit from the rising volumes in the domestic market apart from its increasing focus on non-automotive industries as well.

Business
BFL, the flagship company of Kalyani Group, is one of the leading global manufacturers of forged and machined components for the automotive and non-automotive sectors.

The firm manufactures various critical and safety components for engine and chassis applications for the automotive industry. Its product portfolio comprises closed die forgings, including crankshafts, front-axle beams, steering knuckles, connecting rods, as well as valves, chokes, casing heads and shells for automotive applications.

BFL also manufactures specialised components for the aerospace, power, energy, oil & gas, rail & marine, mining & construction equipment and other industries.

The company has 11 manufacturing facilities in five countries with four in India, three in Germany, two in China and one each in Sweden and the US.

The company has also recently forayed into capital goods space by forming joint ventures with Alstom for manufacturing supercritical turbine generator (TG) with capacity of 5,000 mw and auxiliaries.

The company has also formed a JV with NTPC to focus on balance of plant (BoP) with products like pumps, critical pipings, valves and heavy castings. BFL has also made its presence in EPC (engineering, procurement and construction) space with its subsidiary taking up projects in power and other sectors.

While India (standalone) operations contribute almost 64% to total revenues, it generates remaining 36% from overseas subsidiaries. Geographically, domestic sales in India formed 32% of the consolidated revenues in the fiscal 2010 while overseas markets such as the US, Europe and Asia Pacific contributed 15%, 41% and 12%, respectively. Product-wise, the company derived 26% of consolidated revenues from commercial vehicle chassis in the fiscal 2010, 25% from passenger vehicle chassis, 29% from diesel engines and rest 20% from non-automotive applications.

Investment rationale
BFL last year suffered on account of global slowdown and higher restructuring costs involved in turning around overseas subsidiaries which resulted in it reporting losses at net level. But the company has been able to restructure its overseas operations and the demand in US and Europe for medium and heavy commercial vehicles has also started picking up, though it is still well below the historic highs.

Domestic automotive CV market continues to remain buoyant due to higher industrial and infrastructure activities and is expected to grow at over 12% over next two years. Also with change in emission norms, BFL, which has technological edge over its smaller competitors, is well placed to garner a larger market share.

Internationally, the company saw its standalone sales from Europe and US markets grow by 148% and 32%, respectively on an annual basis aided by higher CV growth in these regions and also due to higher non-auto revenues.

The company expects to see considerable volume growth in US markets on the back of replacement demand, given the average fleet age is closer to seven years.

The contribution to standalone revenues from non-automotive business has been steadily increasing from 26% in the third quarter last year to 37% in the latest December quarter on the back of improved traction from the export markets across sectors such as oil & gas, construction equipment, rail & marine.

The management is targeting to generate nearly 40% of its consolidated sales (currently 30%) from high-margin non-automotive business which would help improve margins and increase diversification. The operating margins are expected to get better in coming quarters as utilisation levels and operational leverage increase.

BFL would also benefit from the huge government spending on infrastructure over the next several years. The capital goods segment would see revenues coming from sales of specialised forgings to power, transportation, construction and mining apart from EPC and TG in the power segment.

Concerns
Any adverse macro environment leading to decrease in government and industrial sector spending or rise in interest rates and commodity prices would affect its revenues and profitability. The company in its international operations may suffer in case European economy remains weaker for prolonged duration.

Valuations
Driven by higher volume growth in auto and increasing contribution from its non-automotive segment, the revenues are expected to grow at a CAGR of 29% during fiscal 2010 to 2012 while the net profit is expected to rise to Rs438 crore in fiscal 2012 from loss in fiscal 2010.

At current market price of Rs333, the company’s stock trades at 27.65 times its expected fiscal 2011 earnings per share and 17.71 times its fiscal 2012 estimated earnings. Investors with medium- to long-term perspective can consider the stock on declines.
Disclaimer: The writer does not hold any share in the company