Wednesday, May 9, 2012


Initiating at Buy: Past Investment Phase

Key Takeaway
We initiate coverage of Bharat Forge (BFL) with a Buy rating and price target of Rs441. We believe that Bharat Forge is past its investment stage and will now benefit from improving asset utilisation. While some of its overseas subsidiaries are still under stress, we expect the management to take remedial action soon. Building blocks in place: Over the past few years, BFL has expanded its presence into newer markets and segments, even as it has maintained its hold over existing businesses. BFL is now the world’s largest independent forging company but still accounts for less than 1.5% share of the estimated global forging production. In the near term, we expect BFL to benefit from the rebound in the US truck market and increasing value addition in the Indian truck market. Expansion into non-auto segments should bring new growth opportunities and offset the cyclicality of the auto business.

It’s all about utilisation: Forging is a capital-intensive business with profitability contingent on asset utilisation and the extent of value addition (machining vs raw forging). BFL increased its raw forging capacity by over 60% in FY09/FY10, even as its end markets slowed down, leading to a sharp fall in utilisation levels (80% in FY08 to 34% in FY10). Since then, however, BFL has benefited from three factors, which will likely accelerate: a) higher utilisation of forging capacity, increasing to 57% in FY12E and to 65% in FY14E; b) higher proportion of machining, from 40% historically to c45% in FY14E; and c) higher proportion of non-auto sales, from <30% historically to c40% at stable state.

Subsidiaries and JVs - no more cash calls: BFL's overseas units account for c50% of global capacity but are operating at less than 50% utilisation. It has shut down one of its European plants and we expect BFL to take more such remedial actions in the future. Cumulatively, we expect the overseas subsidiaries to be self-funding, though they would contribute very little to profits in the near term. We are concerned with the profitability of the power equipment JV with Alstom given the intense competition in the TG space.

BFL stock has been sharply derated since 2008, initially due to slowdown in demand but subsequently due to concerns on its subsidiaries. Our SOTP-derived PT of Rs441 is based on: a) increasing asset utilization in its India operations, which we value at 16x FY14E; and b) no incremental cash calls from its JVs and subsidiaries, which we value at 0.5x FY13E BV to factor in our concerns on profitability. Risks: New expansion in the domestic business, cash calls from international subsidiaries and execution delays in power equipment JVs are key downside risks. Currency fluctuation is a risk for margins.

To read report in detail: BFL