The Hindu Business Line : Bharat Forge: Hold

Shareholders can continue to hold the Bharat Forge stock with a two- to three-year perspective. At the current market price, the stock trades at around 23 times the trailing twelve-month earnings. Although an increased reliance on exports, higher interest costs and a weak domestic demand are expected to affect margins in the near term, improved capacity utilisation, the foray into a non-automotive business and an increased focus on value-added components signal good prospects over a longer timeframe.

The operations of the Germany-based CDP GmbH and CDP Aluminiumtechnik, acquired in 2004, have been fully integrated and further investments made in increasing its capacity. To gain access to the US market, Bharat Forge, in June 2005, acquired Federal Forge which is into the design and manufacture of complex forged steel components. More recently, the acquisition of a Swedish company, Imatra Kilsta, and its subsidiary, Scottish Stampings, a heavy-duty diesel engine crankshaft producer, has given access to new customers and helped in its diversification strategy.

Financials

The first quarter revenue growth was subdued mainly due to a lower off-take in the domestic automotive markets (as higher interest rates slowed vehicle sales). On the export front, there was a slowdown in the US commercial vehicle market (due to front-ending of purchases caused by a change in emission norms). However, revenues grew by 31.5 per cent mainly due to doubling of exports to Europe. A near-10 per cent appreciation in the rupee during the first quarter took its toll on export profits. Standalone operating margins stood at 20.4 per cent as against 24-25 per cent levels maintained in the previous quarters.

Higher interest and depreciation costs due to ongoing capital expenditure have also dragged down profit margins, but can be expected to deliver a better product mix and higher volumes over two-threeyears. Net profits (after adjusting for forex gains to the extent of Rs 33.33 crore) fell by over 40 per cent year-on-year.

Long-term positives

Although the slowdown and margin pressures have impacted earnings, the company has made several strategic moves which lend strength to its long-term growth prospects.

Dual-shore manufacturing model: Under this, offshore locations would be used as a technical hub with emphasis on product design, development and manufacture of high-value critical components while Indian facilities would be used in hig h-volume production due to their low-cost advantage. This will benefit the company in terms of optimising costs and broadening the scope of products across locations.

Domestic capacity expansion: The company is setting up a centre for advanced manufacturing at Baramati in Maharashtra for producing high-end forged components. This unit will commence production in March 2008. The centre will support t he company’s foray into sectors such as oil and gas, energy and aerospace, further de-risking the revenue model.

Move towards high value-added segments: An improvement in the margins will be seen when the revenue mix tilts towards machined components rather than raw forgings. Machined forgings contribute close to half the revenues now.

De-risking of the US business: In the first quarter, the drop in the traditional heavy truck chassis component business by over 25 per cent was compensated to some extent by the increase in the sale of passenger car and non-automotive applications. The market is expected to recover in early 2008.

Revival of China business: The company entered into a joint venture with FAW (First Auto Works) of China in September 2005, but sales have not been up to expectation . The tide though may change with the Chinese commercial vehicle mark et growing by 33 per cent this quarter. The operations are expected to break-even this year and contribute to the consolidated earnings from FY-09.

Broadening client relationships: From being a parts supplier, the company, through its European facilities, is graduating to a provider of product design and engineering services. As a full service provider the company may win high-val ue contracts for long-term supplies, thus ensuring stability of revenues. In 2006-07, the company has already won three $50 million-plus contracts.

Risks

More than 40 per cent of the revenues from the Indian operations come from exports and the company is exposed to risks of an appreciating rupee. Besides, high-value contracts such as those recently signed are bound to increase the non-rupee revenues. The company plans to mitigate the forex risk by improving efficiencies and focussing on cost-reduction, by negotiating with vendors for reduction in dollar-based costs and by renegotiation of prices with customers.

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