Primed for recovery Earnings growth to accelerate with ~27% CAGR (FY14-17E)
* Bharat Forge (BHFC) has emerged stronger, leaner and healthier from the downcycle, driven by its proactive strategic shift towards a stable, broad-based and greater value-adding business model. It is now one of India’s largest engineering exporters.
* It is primed for recovery in the global investment cycle. This, coupled with an expanded product/market mix, would drive strong revenue CAGR of 16% CAGR over FY14-17. EPS would grow at a CAGR of ~27%, aided by robust margin expansion.
* While the stock has outperformed over the last six months, there are several triggers for continued outperformance. These include: (a) volume recovery led benefit of operating leverage, (b) improving segment mix, (c) balance sheet deleveraging, and (d) improvement in capital efficiencies.
* Valuations at ~17.9x/14.9x FY16/FY17E consolidated EPS of INR32/INR39 are attractive for a global leader in forgings and at a discount to the 5/10 year average of 22x/26x. We initiate coverage with a Buy rating. Our target price of ~INR710 (~22x FY16E EPS) suggests an upside of ~23%.
Stronger, leaner and healthier
BHFC has broadened its revenue stream by entering new segments (non-auto) and global markets. The share of auto business has declined from ~80% in FY07 to ~60% in FY13 and the share of India has reduced from ~60% to ~48% in standalone operations. Further, it has increased value-addition by focusing on machined components, the contribution of which has increased to ~51% in FY13, boosting realizations and margins. Lastly, it has improved its balance sheet by focusing on controlling debt through lower capex, resulting in fall in net debt-equity to ~0.3x/0.2x by FY15/FY16.
Auto business – awaiting CV cycle recovery; focusing on PVs
Benefit of US Class-8 demand improvement, driven by pre-buying before emission norm changes and gradual recovery in the EU would reflect in FY15/FY16. BHFC is a clean play on the expected domestic CV cycle recovery from 2HFY15, with over 60% market share in M&HCV components. The PV segment is a focus area for BHFC and could be an important growth driver. This segment offers an opportunity size 4x that of CVs.
Non-auto business – play on investment cycle recovery
The non-auto segment offers significant growth potential, as it is much larger than the auto segment. BHFC is targeting ~60% of its standalone revenues from the non-auto segment, up from the current ~40%. Its partnerships with global players (Alstom, Areva, David Brown, etc) bear testimony to its globally cost competitive engineering/manufacturing capabilities. BHFC’s increasing penetration with existing and new customers, coupled with economic stability in the international market and investment cycle recovery in India, would drive ~24% revenue CAGR in the non-auto segment. Increasing contribution of nonauto to consolidated revenues augurs well for profitability and capital efficiencies, given the segment’s higher realizations, margins and asset turns.
Multiple levers to support/improve profitability
We expect consolidated revenues to grow at a CAGR of ~16% over FY14-17 (adjusted for FAW JV exit), driven by 22% CAGR in India revenues and 12% CAGR in international revenues. EBITDA margin should expand ~290bp to 18.2%, driven by higher exports from India, rising contribution from non-auto business and machined components, and operating leverage. BHFC has sufficient capacities to drive over 25% revenue CAGR over the next two years, necessitating maintenance capex of INR1.5b-1.8b per year. We estimate cumulative FCF generation of ~INR21b during FY15-17, enabling reduction of net debt to ~INR7b (net debt-equity of 0.2x) from ~INR13.4b (net debt-equity of 0.8x). Improving asset turns and profitability would drive improvement in consolidated RoE to ~22.6% in FY17 from 17.9% in FY14 – the highest RoE since FY07.
Valuations attractive for global leader in forgings; Buy
BHFC is primed for recovery in the global investment cycle. While the stock has outperformed over the last six months, there are several triggers for continued outperformance. These include: (a) volume recovery led benefit of operating leverage, (b) improving segment mix, (c) balance sheet deleveraging, and (d) improvement in capital efficiencies. Valuations at ~17.9x/14.9x FY16/FY17E consolidated EPS of INR32/INR39 are attractive for a global leader in forgings and at a discount to the 5/10 year average of 22x/26x. We initiate coverage with a Buy rating. Our target price of ~INR710 (~22x FY16E EPS) suggests an upside of ~23%.
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* Bharat Forge (BHFC) has emerged stronger, leaner and healthier from the downcycle, driven by its proactive strategic shift towards a stable, broad-based and greater value-adding business model. It is now one of India’s largest engineering exporters.
* It is primed for recovery in the global investment cycle. This, coupled with an expanded product/market mix, would drive strong revenue CAGR of 16% CAGR over FY14-17. EPS would grow at a CAGR of ~27%, aided by robust margin expansion.
* While the stock has outperformed over the last six months, there are several triggers for continued outperformance. These include: (a) volume recovery led benefit of operating leverage, (b) improving segment mix, (c) balance sheet deleveraging, and (d) improvement in capital efficiencies.
* Valuations at ~17.9x/14.9x FY16/FY17E consolidated EPS of INR32/INR39 are attractive for a global leader in forgings and at a discount to the 5/10 year average of 22x/26x. We initiate coverage with a Buy rating. Our target price of ~INR710 (~22x FY16E EPS) suggests an upside of ~23%.
Stronger, leaner and healthier
BHFC has broadened its revenue stream by entering new segments (non-auto) and global markets. The share of auto business has declined from ~80% in FY07 to ~60% in FY13 and the share of India has reduced from ~60% to ~48% in standalone operations. Further, it has increased value-addition by focusing on machined components, the contribution of which has increased to ~51% in FY13, boosting realizations and margins. Lastly, it has improved its balance sheet by focusing on controlling debt through lower capex, resulting in fall in net debt-equity to ~0.3x/0.2x by FY15/FY16.
Auto business – awaiting CV cycle recovery; focusing on PVs
Benefit of US Class-8 demand improvement, driven by pre-buying before emission norm changes and gradual recovery in the EU would reflect in FY15/FY16. BHFC is a clean play on the expected domestic CV cycle recovery from 2HFY15, with over 60% market share in M&HCV components. The PV segment is a focus area for BHFC and could be an important growth driver. This segment offers an opportunity size 4x that of CVs.
Non-auto business – play on investment cycle recovery
The non-auto segment offers significant growth potential, as it is much larger than the auto segment. BHFC is targeting ~60% of its standalone revenues from the non-auto segment, up from the current ~40%. Its partnerships with global players (Alstom, Areva, David Brown, etc) bear testimony to its globally cost competitive engineering/manufacturing capabilities. BHFC’s increasing penetration with existing and new customers, coupled with economic stability in the international market and investment cycle recovery in India, would drive ~24% revenue CAGR in the non-auto segment. Increasing contribution of nonauto to consolidated revenues augurs well for profitability and capital efficiencies, given the segment’s higher realizations, margins and asset turns.
Multiple levers to support/improve profitability
We expect consolidated revenues to grow at a CAGR of ~16% over FY14-17 (adjusted for FAW JV exit), driven by 22% CAGR in India revenues and 12% CAGR in international revenues. EBITDA margin should expand ~290bp to 18.2%, driven by higher exports from India, rising contribution from non-auto business and machined components, and operating leverage. BHFC has sufficient capacities to drive over 25% revenue CAGR over the next two years, necessitating maintenance capex of INR1.5b-1.8b per year. We estimate cumulative FCF generation of ~INR21b during FY15-17, enabling reduction of net debt to ~INR7b (net debt-equity of 0.2x) from ~INR13.4b (net debt-equity of 0.8x). Improving asset turns and profitability would drive improvement in consolidated RoE to ~22.6% in FY17 from 17.9% in FY14 – the highest RoE since FY07.
Valuations attractive for global leader in forgings; Buy
BHFC is primed for recovery in the global investment cycle. While the stock has outperformed over the last six months, there are several triggers for continued outperformance. These include: (a) volume recovery led benefit of operating leverage, (b) improving segment mix, (c) balance sheet deleveraging, and (d) improvement in capital efficiencies. Valuations at ~17.9x/14.9x FY16/FY17E consolidated EPS of INR32/INR39 are attractive for a global leader in forgings and at a discount to the 5/10 year average of 22x/26x. We initiate coverage with a Buy rating. Our target price of ~INR710 (~22x FY16E EPS) suggests an upside of ~23%.
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