CMP: 291          Date: 12-08- 2011          Advice: Invest in SIP fashion

• Till 2006 Bharat Forge (BF) was primarily an auto components firm. A number of mergers and acquisitions in the 2004-07 periods saw BF also enter in several new geographies. Manufacturing is in 11 locations and 5 countries: India (4), Germany (3), China (2), Sweden (1) and USA (1).
• In the last 3 years, BF has executed a de-risking plan and enter into new verticals. For BF the focus in the Non-Auto business is on growing sectors like Power Plants, Marine, Construction & Mining, Oil & Gas, Energy, Aerospace and Railways, and Import substitution for BHEL.  JVs are with respected partners, like NTPC for power, Alsthom for Thermal/ Nuclear turbine/ generation sets and UK based David Brown for gear box manufacturer

Change in Revenue Segments

Fig 1 – Business Segments in 2011 (click chart to expand)

 Bharat Forge has successfully diversified from Auto into other verticals, de-risking their overall business profile

Current Business Outlook

• The fall in auto demand in 2007-09 saw cost cutting measures rolled out to lower the break even for manufacturing facilities. Capacity utilization improved from 53% in 2009, to 70% for standalone and 45% for international entities in 2010. Additional improvements have contributed significantly to profits. All overseas subsidiaries, including its JV in China, FAW Bharat Forge, have see a turnaround and have started contributing to the bottom line, a year ahead of the 2012 target.
• The auto market began to revive in 2009, and BF was best placed to take advantage of this trend.
• In June 2011, Bharat Forge quarterly revenues surged to 857 crores, an all time high.
• The Business environment and demand situation has now become very positive. BF is able to take advantage of surging demand due to spare capacities, low cost production, global presence and nimble design capabilities. Also a series of well timed entries into new non-automotive markets.

Quarterly sales and Net Profits

 Fig 2 – Quarterly revenues have surged (click chart to expand)

 Business is surging, in both Auto and non-Auto segments. Profit growth follows in a phased manner, as investments in new businesses break even

Valuations are low, growth is high

• The stock price peaked in 2006 and has not touched those levels since. But BF has seen a dramatic business recovery in the last two years in terms of Earnings per share – EPS, which has already risen to all time highs.
• While the BF stock has given investors only 11% CAGR returns over a 7-year period, the aggressive nature of this firm means that the initial period of rapid gain was followed by a period of restructuring and consolidation. The expectation now is another period of rapid gain on all parameters.

1. Adjusted EPS has seen a recovery post ‘09 and is now into all time high territory
2. Debt-equity is 0.74 as of Mar’11 (down from 1.21 in ‘10). This is comfortable, and safe.
3. ROCE and RONW are in 15-17% range indicating healthy returns.
4. PE has fallen to reasonable levels (compared to historical) indicating safety in investments at this level.
5. PEG is in the range of 0.3, indicating indicates high safety and undervalued status

Fig 3 - EPS and Cash Flow

Fig 4 - Price and PE

Fig 4 – PE has fallen to attractive levels, and combined with robust business performance gives us a very good entry point for long term investments – (click chart to expand)

Fig 5 - Price and EPS

Fig 5 – Adjusted EPS has retraced rapidly and is into all time high territory

Projection

• Bharat Forge has been in a period of consolidation, and will see a break out soon
• EPS has moved to all time highs. With a suitable lag, this will be followed by stock price also moving into new highs. The stock will appreciate to Market Price of 700 in 12-14 months. This is based on an expected PE of 30 range and continued EPS growth seen since the bottom of June 2009.
• This is an excellent entry point for this stock as it is currently underpriced and ‘out of favour’. The current market weakness has dragged down the market price of the stock. With overall Sensex / market recovery expected in 6-9 months, this share price is expected to recover rapidly.

Risks

• Auto sector demand in India has been tapering off in recent months. It is expected to have lower growth for 2-3 quarters before recovering. Auto Exports however from India are accelerating.
• Headwinds, such as Higher raw-material costs like steel and power may restrict margin expansion and EPS growth. The rising commodity costs have hit manufacturers like Bharat Forge.
• In recent months the increase in interest rates and slowdown in the economy has slowed the growth of the auto industry, particularly in India.
• However, both these events appear to have played out/peaked, and will stabilise/ reduce in the near future.
• Business complexity has increased due to addition of a number of new verticals. However, BF is already seeing exciting success from the new ventures.
• An increase in working Capital in the firm in 2011 saw the Cash Flow fall this year. This stems from investments in new businesses as well as new investments in the Auto business to increase capacity and de-bottlenecking.
• External factors like stock market sentiments. However our current view is that this will revert to a positive state over the next 9-12 months.

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Disclaimer:

These reports and documents have been prepared by JainMatrix Investments Ltd. They are not to be copied, reused or made available to others without prior permission of JainMatrix Investments. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com Also see: https://jainmatrix.wordpress.com/disclaimer/

Introduction

• Bharat Forge is a Pune based manufacturer of forged and machined – engine & chassis components. It is the largest exporter of automotive forgings and chassis components from India. It is the second largest in the world, after ThyssenKrupp of Germany.
• Manufacturing facilities are spread across 11 locations and 5 countries – four in India, three in Germany, one each in Sweden, USA and two in China.
• The company manufactures a wide range of safety and critical components for passenger cars, SUV’s, light, medium & heavy commercial vehicles, tractors and diesel engines. The company also manufactures specialized components for the aerospace, power, energy, oil & gas, rail & marine, mining & construction equipment, and other industries. Parts are made of steel and aluminium.
• Business growth has been steady over the last 7 years. The fall from end 2008 to end 2009 due to a global slowdown, and this has been followed by a rapid recovery thereafter.
• Pre- 2004, Bharat Forge was focused on increasing capacity and the Pune facility became the largest single forging and casting plant.

Fig 1 – In Sept 2010, Bharat Forge achieved all time high revenues of Rs 719 crores, signaling full recovery.

Fig 2 – Business Segments in 2009

M&A

• A number of mergers and acquisitions in the 2004-2007 period saw Bharat Forge expand to new geographies. In the process it added a number of prestigious customers and was able to supply products to almost all the major automotive firms worldwide as OEM

Diversification

• Till 2006 Bharat Forge was primarily an auto components firm. The auto demand collapse and forward looking corporate de-risking plans saw the firm fast track entry into other verticals in the period from 2006 to date.
• Internal targets are to double non-automotive business from 20% in 2008 to 40% by 2012.
• For Bharat Forge the focus in the Non-Auto business is on fast growing sectors like Power Plants, Marine, Construction & Mining, Oil & Gas, Energy, Aerospace and Railways. Also on Import substitution for BHEL which itself is a big opportunity. Diversification into these sectors is through a series of JVs with respected partners (eg NTPC for power and Alsthom for Thermal/ Nuclear turbine/ generation sets

Current Business Outlook

• The fall in auto demand in 2007-09 saw cost cutting measures rolled out to ensure a lower break even for these facilities. Capacity utilization was 53% in 2009. This has improved to 70% for the standalone entity and 45% for international entities in 2010. From here all improved utilization will contribute significantly to profitability. We do not anticipate a need for auto capacity increase for several years.
• As a result of these business initiatives, when the market began to revive in 2009 for auto industry, Bharat Forge has been best placed to take advantage of this trend.
• Demand is increasing from both domestic business – Commercial Vehicles and Passenger cars, as well as international – UK and USA. Demand growth is led by India and China, and developed economies have stabilized and are expected to slowly recover in terms of business volumes.
• The Society of Indian Automobile Manufacturers (SIAM) releasing the 2010 sales growth data of 14.82 million units as against 11.32 million units registered in 2009. Sales of passenger vehicles segment grew by 31.34 percent, commercial vehicles segment by 45.24 percent, three-wheelers by 22.03 percent and two-wheelers by 30.51 percent. They said that the growth was due to increasing dispensable incomes, low interest rates and increase in sales base at par with the pre-recession era.
• The firm has seen all of its overseas subsidiaries, including its joint venture in China, FAW Bharat Forge, turn around and start contributing to the bottom line, a year ahead of the 2012 target
• India is emerging as a small car-manufacturing hub, with a number of new entrants and a slew of product launches. The luxury market too has grown rapidly. As the market matures, mid sized sedan volumes too will grow. Bharat Forge is a supplier to virtually all the auto manufacturers in India as OEM.
• Demand for Bharat Forge’s auto components is a derived demand – dependant upon the Auto manufacturers for sales. The India domestic auto market is doing well with many auto models having a ‘waiting period’ of 2-4 months for delivery after booking by the consumer.

Conclusions, projections and Investment advise

Valuations and conclusions

• The chart (Fig 3) plots the market price (adjusted) against EPS (adjusted) over a 7-year period.
• The stock price peaked in 2006 and has not touched those levels since. But we can see the dramatic business recovery of Bharat Forge in the last one year in terms of EPS
• The PE of Bharat Forge (Fig 4) has been at high levels of late – rising to as high as 80 times. However if you see this in the light of the short-term squeeze in business environment, this is a passing phase.
• The Business environment and demand situation has now become very positive. Bharat Forge is well placed to take advantage of surging demand due to sufficient spare capacities, low cost production facilities, global presence and nimble design and manufacturing capabilities. Also a series of well timed entries into new non-automotive markets.
• We expect EPS to continue recovery and move to all time highs. This will be followed by stock price also moving into new highs territory.
• Net Cash From Operating Activities has shown a positive trend, barring FY 2009.
• Debt equity is 1.21 as of March 2010. This is not too high and is 3.5 times the Net Cash From Operating Activities

Fig 3 – Current PE looks high but seen in the context of a rapidly increasing EPS, improving capacity utilization and positive business outlook, it will soon settle to lower levels.

Fig 4  – Adjusted EPS has retraced rapidly and is nearing the 2008 peak.

Projection

• We expect the stock to appreciate to Market Price of 700 in 18 months.
• This is an excellent entry point for this stock as it is currently underpriced and ‘out of favour’. The the next 2-3 quarterly results will be positive and the share price may start to reflect it’s true worth.

Risks

• Higher raw-material costs like steel and power  may restrict margin expansion and EPS growth.
• Low cost domestic capacity may get exhausted, requiring additional capital investments.

• Business complexity has increased due to addition of a number of new verticals. Management bandwidth and Vertical/ Technical skill-sets need to be upgraded to meet the business challenges.

• New subsidiaries and JVs need to rapidly add capacity and win deals – early stage of new businesses are uncertain and need management attention before business stabilizes.
• External factors like stock market sentiments. However our current view is that this will be positive over the next 12 months at least

Disclaimer:

These reports and documents have been prepared by JainMatrix Investments Ltd. They are not to be copied, reused or made available to others without prior permission of JainMatrix Investments. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com Also see: https://jainmatrix.wordpress.com/disclaimer/