Stock Review: BHARAT Forge (BFL)

With better revenue visibility and focus on diversification, Bharat Forge is a reasonable investment bet for the long term

 

   BHARAT Forge (BFL) was struggling to deliver reasonable financial performance over the past three years. But a revival in global auto demand, restructuring of its lossmaking overseas units and a business diversification strategy have helped the company turnaround in its performance in the current fiscal.

   The forgings company has posted an average growth of 50% year-on-year in both revenue and net profit in the past three quarters. This is due to a revival in demand for commercial vehicles with improvement in business sentiments in the domestic market, besides better sales numbers from US and European markets. The company's plan to increase share in non-automotive segment as part of its diversification strategy also helped it perform well.

   With expectation of sustainable growth in commercial vehicles, the company is expected to sustain its performance in the coming quarters. Long-term investors with a time frame of two years can consider this stock.

BUSINESS:

BFL is one of the top global forging companies with presence in six countries across Asia, Europe and the US, with a capacity of 7.6 lakh tonne per annum. It has four wholly-owned subsidiaries outside India besides a joint venture in China.
   Given the global demand for automobile forging, BFL struck multiple overseas deals. The company acquired Germany-based companies Carl Dan Peddinghaus (CPD) and Aluminium Technik in 2004. In the following year, it bought Sweden's Imatra Kilsta and US-based Federal Forge that boosted its presence in the European and American automobile markets. BFL draws a third of its sales from the domestic market with another 21% coming from exports to the US, its chief exports market, and Europe. BFL generates more than half of its revenues from supplying forging parts to commercial vehicles followed by passenger vehicles.

GROWTH DRIVERS:

With an industry estimation of a compounded annual growth rate of 13% in commercial vehicle sales during FY10-12, BFL is expected to be one of the biggest beneficiaries in the medium term. The gradual revival in global economy also poses a positive outlook for the firm. After facing a slowdown in demand in the past two financial years, BFL had adopted various measures to fight the pressure on bottomline, including rationalisation of production and pruning fixed cost in its overseas subsidiaries. Given its focus on business diversification, a little less than the third of its consolidated revenue for the quarter ended December 31, 2010 came from non-automotive segment. BFL plans to raise it to over 50% in the next two years. It has already expanded its non-automotive forging capacity in two of its manufacturing facilities to relatively insulate itself from any negative surprises in the automotive segment. To reap the benefit of growing demand in the power sector, it has also entered into a joint venture with engineering company Alstom and power generation firm NTPC to manufacture supercritical power plant equipment in India. This JV is expected to contribute to the topline from FY13 onwards.

FINANCIAL PERFORMANCE:

The company reported a net loss of 76 crore in FY10 on the consolidated basis due to losses in its three overseas subsidiaries. But for the nine months ended December 31, 2010, it has generated growth with revenues almost doubling to 3,359 crore and net profit growing three-fold to 196 crore.

VALUATIONS:

Expectations of a sustainable growth in demand for commercial vehicles in the domestic market in the coming quarters, albeit at lower pace, it will act as a catalyst for earnings growth in the near term. Further, as the company draws majority of its business from international market, it will provide an upside to consolidated revenues. At over 335, the scrip trades 42 times its consolidated profit for the 12 months ended December 31, 2010 that is higher than the industry average of auto component industry. This could be due to the fact that BFL enjoys the premium being leader in its segment. We expect the company to post a consolidated net profit of 290 crore the year ending March 2011 and 471 crore in the coming financial year. This means BFL scrip is trading around 16 times the estimated forward earnings for FY12. With good revenue visibility due to its dominant position, BFL is a reasonable investment bet for the long term.

CONCERN:

Currency fluctuations can impact BFL's revenues since it derives a large portion of its revenue from global markets. BFL has a debt-equity ratio of 1.35 on consolidated basis for FY10, which could be of concern if the company is not able to maintain its growth momentum in the long term.