Bharat Forge organised a meeting with analysts to discuss the company’s business plans. We were impressed by the efforts it has made to scale-up various segments of its business and develop new products to double its standalone revenues over the next five years. FY2016 is likely to be a weak year for the company, led by slowdown in the US truck market and oil & gas industry (~40% of standalone revenues) but new products/verticals will likely result in 16% CAGR (compound annual growth rate) in revenues in the FY2016-18 period. We maintain BUY with a revised target price of R965 (R975 earlier).
Scaling up the technology curve and sowing seeds for robust growth ahead: FY2016 is likely to be a weak year for the company, led by slowdown in the US truck, oil & gas and mining sectors which constitute 40% of Bharat Forge’s standalone revenues. The company is working on developing new products for the existing and new customers to increase its presence across various verticals. A key point to note is that it will be using its existing facilities to develop new products which gives us an idea of their flexible manufacturing practices. The four key areas of growth over the FY2015-18 period are likely to be: (i) 3X increase in passenger car forging revenues, led by new order wins from GM, Ford and Volkswagen, (ii) New order wins in the aviation segment which will likely add incremental $50m in revenues by FY2018, (iii) Import substitution in the Indian railways as GE (locomotive supplier) looks to localise in India and (iv) new transmission components developed for passenger vehicle OEMs where the company was not present earlier. We believe the transmission component business could add incremental $100m in revenues to the company. The company reasserted its guidance to achieve R70 bn in revenues in standalone by FY2018 while we are more conservative and build in R62 bn. We have not factored in opportunities in transmission components in our estimates as yet.
We cut our estimates by 3-5% over FY2016-18 to factor in weakness in the US truck business We have cut our consolidated earnings estimates by 3-5% over the FY2016-18 period led by 10-15% cut in our estimates for the US truck forging business revenues. We have cut our consolidated Ebitda estimates by 4-5% over the same period as the US truck business offers higher margins. We have thus cut our target price to R965 (from R975 earlier) driven by 3-5% cut in our earnings estimates. We have increased the target multiple for the standalone business from 22X to 23X on September 2017 EPS, as we believe the company is well placed to deliver strong revenue growth over the FY2016-20 period.
** The company expects flat revenue growth in FY2016e and reaffirmed its FY2018e revenue guidance of R70 bn: Overall, the company expects revenues to be flat y-o-y in FY2016e as revenue decline in industrial segments (primarily oil & gas and mining) will be offset by the ramp-up in passenger vehicle revenues and growth in the domestic truck business. The company reaffirmed its FY2018e standalone revenue guidance of R70 bn. We expect standalone revenues of around R62 bn in FY2018e as we have not built in revenue opportunity from new transmission components in our estimate.
** US heavy truck industry volumes will decline over the next two years: The company’s guidance points to Europe and US heavy truck volumes declining by 6% y-o-y and 4% y-o-y in CY2016e and CY2017e respectively. US heavy truck volumes will likely decline by 16% in CY2016e and 9% y-o-y in CY2017e while in Europe, heavy truck volumes will increase by 5% y-o-y in CY2016e and 2% y-o-y in CY2017e. The company has received new orders from Paccar and DAF in the US to which it did not supply earlier; hence its market share in the US will likely go up.
** Revenues from the passenger vehicle segment to grow 3X over the next three years: Bharat Forge has received orders from global OEMs including GM, Audi, Daimler, Chrysler, to supply machined forging components for passenger vehicles. This will drive strong revenue growth over the next three years. We expect passenger vehicle revenues to increase to around R10 bn in FY2018e from ~R3 bn in FY2015. Passenger vehicle segment revenues will account for ~15% of revenues in FY2018e as compared to ~5% in FY2015 as per the company.
** Developing capabilities to start manufacturing transmission components: Over the past 18 months, the company has developed transmission components for passenger vehicle OEMs. This is a new opportunity for the company as it does not manufacture transmission components currently. Kalyani Technoforge, a part of the Kalyani Group, acquired the Indian operations of Bodycote, a leader in thermal processing services worldwide in September 2015. Bodycote offers specialised surface treatment processes such as carburising, plasma nitriding, carbonitriding which are used for products such as high precision gears required for transmission and aerospace applications. We estimate transmission components in passenger vehicle forging to be ~$2 bn industry globally. Bharat Forge can incrementally add $100m in revenues in the transmission space by gaining 5% market share in the transmission component space.
** Revenues from aerospace segment will ramp-up in FY2017-18: The company has received orders for aerospace components from four customers. This vertical could scale up to $100m in four to five years. We expect this vertical to be a key growth driver for the non-auto export business in the next two years. We estimate the aviation component business to become a $50m vertical for Bharat Forge by FY2018.
* Defence could be another opportunity over the next five years: Bharat Forge will supply components for artillery systems for the defence industry. It highlighted the likelihood of the defence ministry floating tenders for $5bn in orders for defence systems which need to be supplied over the next
10 years. We estimate forgings to form 25% of these orders. Hence, forging components in the defence industry could be an opportunity worth $1.25 bn over the next 10 years for Bharat Forge which implies an annual opportunity of $125m.
* The company is also developing forging components for sub-sea drilling equipment in which Bharat Forge is not present currently. This will help the company offset the decline in the oil & gas business.
* The company will also supply forging components to GE for locomotives it is developing for the railways. It will also look at servicing Indian Railways’ need for engine parts.
* Hindustan Aeronautics Limited (HAL) imports 85-90% of its requirements of aviation components. Bharat Forge is developing components for HAL to reduce its import content.
* The company expects to become debt free by FY2018 led by strong cash flow generation.
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