The Hindu Business Line : Bharat Forge: Hold

The acquisitions give the company a substantial advantage in terms of entry into new product categories and a broad customer and manufacturing base.

MAKING A foray into non-automotive forgings.

Bharat Forge has been on an acquisition spree over the last five years, foraying into new markets and product lines. With three acquisitions in the last one year in three different markets, 2006-07 will be a year of integration and consolidation. The ongoing capacity expansion plans too will be complete by December and the production ramp-up could happen progressively over the year.

The full impact of the recent acquisitions and the capacity ramp-up on the revenues and earnings will be felt in the financial year 2007-08. At 25 times the expected 2006-07 consolidated per share earnings, we believe the near-term growth prospects are factored into the stock price, partially. As the long-term growth story is still promising, we recommend a hold on the stock.

Gains from acquisitions

Of the five international acquisitions in the last five years, three were concluded last year alone — one each in Sweden, the US and China.

These acquisitions give the company considerable advantage in terms of entry into new product categories, and a broad customer and manufacturing base.

The joint venture with FAW Corporation gives Bharat Forge an access to the Chinese automotive market — the fastest growing auto market in the worldAs Bharat Forge enters this market, China's contribution to its overall revenue stream could increase significantly; it now contributes just 5 per cent.

The acquisition of Federal Forge Inc gives the company access to the US market for light trucks and passenger cars. Bharat Forge already caters to over 50 per cent of the requirements for the heavy truck segment in that country.

At approximately Rs 50 crore, the price paid does not appear stiff for a company with revenues of Rs 117 crore.

MR B. N. KALYANI, MD and Chairman, Bharat Forge

Bharat Forge had begun supplying to the European passenger car segment by acquiring CDP GmbH, Germany, in 2003. The latest acquisition of a Swedish company, Imatra Kilsta, and its subsidiary, Scottish Stampings, will widen its market in Europe.

The Kilsta group is a leader in heavy-duty diesel engine crankshaft for the European and Scandinavian market.

The acquisition would give Bharat Forge access to new customers in Europe and help in the diversification strategy. Bharat Forge's experience with CDP enthuses confidence in its ability to integrate and turn around international businesses to its advantage.

In just two years, Bharat Forge's operating profits grew from Rs 27.5 crore in 2003 to Rs 72.9 crore in December 2005.

We believe the new acquisitions too may take time to pay off and the next two years will be crucial in this respect .

The consideration for the last three acquisitions works out to Rs 435 crore, funded by a mix of debt and equity.

Despite the higher debt financing, the consolidated debt-equity ratio, at less than one, is comfortable.

Though the return ratios are low, as Bharat Forge makes optimum use of its onshore and offshore capacities and the integration process sets in, return ratios may improve.

Diversifying portfolio

Having enhanced its product range in phases, Bharat Forge is now embarking on a major ramp-up in the non-automotive forgings segment. This segment, which now contributes 17 per cent of its revenues, will be a big growth driver.

Opportunities are opening up in sectors such as conventional and non-conventional energy, hydrocarbon explorations, mining, metals and aerospace.

The forgings used in these sectors are usually large in size, small in quantity, but enjoy higher margins. Contributions from this segment are expected to increase in the next couple of years when the capacities are in place.

Capacity expansions

Bharat Forge has been on an expansion binge over the last couple of years. It has completed two phases of expansion and the third will be over by December. Post-expansion, the total forging capacity at its Mundwa plant in Maharashtra will be 2.4 lakh tonnes per annum. These capacities will start generating revenues from early 2007. The company is further investing close to Rs 350 crore in fresh capacities for non-automotive forgings. The planned capacities for this segment are expected to go on stream in the next couple of years.

As the second largest international forgings player, Bharat Forge enjoys better operating profit margins at 20 per cent compared to the No. 1 global forging company — the Thyssen group — which has considerably lower profit margins.

The 5 per cent modest earnings growth for the standalone company in the first quarter of 2006-07 reflects the transitional phase where investments made in the course of the year have not begun yielding results.

Though interest costs and depreciation are rising, the capacities have not started functioning to their full potential. As production ramps up and capacity utilisation improves, the profitability ratios could improve.

Consolidated numbers

A 55 per cent growth in consolidated revenues in the first quarter of 2006-07 reflects, to a large extent, the incremental business brought in by the new acquisitions made in 2005-06.

The consolidated earnings growth at 16 per cent, however, was subdued, as the acquisitions are expected to take time to integrate and show up in the earnings numbers.

Since the margins of the international businesses are relatively lower at 10 per cent compared to 28 per cent on the domestic stand-alone business, the earnings numbers may take time to catch up with revenue growth.

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