A de-risked business model with increasing non-auto revenues, improved performance from its overseas subsidiaries and good prospects in the auto segment make a case for investment in Bharat Forge. The recent market turbulence has seen the stock touch its 52-week low of Rs 259 last week. At the current market price of Rs 262, the stock trades at a PE of around 14 times its estimated consolidated earnings for FY12. Investors with a two-three year perspective can consider exposures.

Opportunities in auto

Manufacturing components such as crankshafts, connecting rods, camshafts and front axle beams for commercial vehicles and passenger cars, Bharat Forge caters to almost all the big names in the automotive industry. BMW, Ford, Daimler, Volvo, Honda, Audi, Toyota, Tata Motors, Ashok Leyland, Maruti and Mahindra & Mahindra are among its clients.

Given that after two successive years of high growth, the domestic auto industry is moderating, the investment recommendation does carry an element of risk. Worries about a slowdown in the US and Europe, two other important markets for the company, also add to the uncertainty.

However, the company appears well-placed to take on these challenges. For one, the domestic industry is faced only with a moderation and not a slowdown of the order of 2008. The fact that dealers don't have the kind of inventory build-up seen in 2008 and that interest rates may peak out soon, support this view.

Good agricultural and export-import growth and spends in the infrastructure space bode well for volume growth in commercial vehicles. Besides, the trend of increased demand for higher tonnage heavy vehicles seen in the last two years imply good business prospects for the company, as these vehicles require more axles and, hence, more forged parts. Also, the new emission norms and the use of advanced turbocharged engines in cars call for more forged components. To cater to these needs, Bharat Forge is expanding capacities by setting up a new press line, to be operational by April 2012.

Bullish export outlook

Fears of a slowdown in the US and Europe, which bring about 35 per cent of the standalone revenues, seem overdone. Bharat Forge exports mainly to medium and heavy commercial vehicles in the US. Considering the fairly high average age of fleets and low inventory levels there, the company expects the demand driven by old fleet replacement to continue. Besides, implementation of new emission norms will lead to increased demand for forgings. The rebounding of the European CV markets since the second half of 2010 is also a sweetener.

Moreover, the company has indicated that the US and European customers have not revised downwards their annual rolling orders, given at the beginning of the year. A 40 per cent growth in exports to the US and a 10-20 per cent growth in exports to Europe is expected as of now. Two other factors also de-risk Bharat Forge's export revenue base. One, the company's plans to set up its manufacturing footprint in emerging markets such as Latin America and Asia (excluding China). Two, the presence of revenues from the non-auto segment in the export markets.

Diversification moves

The positive outlook for auto segment revenues notwithstanding, what really acts as a diversifier is the increasing share of revenues from segments other than auto.

The company now manufactures high technology forged and machined components for marine, power, railways, construction equipment and oil and gas industries.

Catering to both the domestic and export markets, non-auto segments now bring about 37 per cent of the company's standalone revenues. By 2016, the company wants this share to improve to about 60 per cent.

For this, it has entered into a joint venture with Alstom for the manufacture of turbine generators for super critical thermal power plants and associated auxiliaries. In another JV with NTPC, Bharat Forge plans to manufacture balance of plant equipment for the power sector.

The company has also joined with UK-based David Brown group, for the manufacture of gear boxes for the heavy engineering industries.

Backed by its diversification moves and strong exports, the company has posted a net profit of Rs 97.4 crore during the first quarter of FY-12 in the standalone operations, recording a growth of 64 per cent year-on-year. Revenues have grown 36 per cent to Rs 858 crore. EBITDA margin for the quarter was maintained at about 24 per cent.

Value addition

Going forward, the company expects to move up the value chain by manufacturing more machined components. The share of machined components, which is at 50 per cent currently, is expected to go up to 65 per cent by FY13. The better product mix and higher realisations arising from greater use of machined components will benefit the company both in the auto as well as the non-auto segments.

Also, considering the increased demand, the company is increasing capacities for the same. From about 8.8 lakh units, machining capacity for crankshafts, for instance, is being increased to 10.2 lakh units currently. Machining capacity for the non-auto segment is also expected to double from the current levels over the next 1-2 years.

Subsidiaries gain traction

Helped by restructuring, higher capacity utilisation, rationalisation of costs and productivity improvements, the company's subsidiaries in Germany, Sweden and the US and the joint venture in China, which cater predominantly to the global auto market, have turned around in 2010.

The overseas operations have continued to post good numbers in the first quarter on the back of strong auto demand. Revenues have grown by 38 per cent year-on-year to Rs 711 crore, while profit before tax was Rs 11 crore as against Rs 7.6 crore in the corresponding quarter of the previous year. EBITDA margins stood at 5.6 per cent. These subsidiaries are expected to continue the good run with margins poised to expand to double-digits in the next 18 months.

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