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Growth drivers remain intact

Bharat Forge (BHFC) has reported EBITDA margin of 25.8% (up 30bps QoQ) despite 160bps gross margin contraction (largely optical effect) led by good control on fixed costs. Revenue growth (up 4% QoQ) was supported by exports improvement and is expected to continue in FY23 on the back of steady demand in US/EU truck segment and orders from EU PV segment. BHFC is expected to reach peak utilisation on its EU aluminium forging capacity with rising demand from EVs/hybrids and ~80% of its German orderbook is from EVs. Strong outlook for aerospace and defence segments would also add to growth potential in industrials other than rising demand outlook from O&G segment. BHFC is passing through a strong growth cycle with multiple levers like: a) Global commodity upcycle (e.g. crude oil), b) electrification of PVs globally, c) global and domestic truck cycle recovery, d) aerospace segment outlook improving; and e) potential defence orders. We believe BHFC is well placed to play the cyclical global recovery and has capability for both technology and funding needs. We value BHFC at a DCF-based target price of Rs890/share (earlier: Rs883), implying 24x FY24E EPS and maintain BUY rating on the stock.

Key takeaways from earnings call:

* Demand from US Class-8 trucks to remain steady in next 12 months despite nearterm weakness in orderbook on the back of capacity limitation, pending orderbook and continued addition of value-added products in the portfolio. BHFC also added fresh DC-DC charger orders for CVs, showcasing its capability for EVs within the CV space. Domestic M&HCV demand to remain strong in coming quarters with Q1FY23 demand being at pre-FY20 levels of ~90-100k units.

* O&G revenue was ~2/3rd of its FY19 peak and would gradually grow from here despite crude oil prices being at much higher levels led by higher capacity utilisation and increasing asset-life cycle of the shale gas assets. Aerospace segment to grow by ~40-45% in FY23E with a flat outlook for railways segment. Aluminium forging capacity has strong orderbook and thus, BHFC is looking forward to reach full utilisation from ~35-40% levels now, even after adding fresh lines in the facilities.

* Aluminium forging capabilities out of India are operating at ~40% utilisation and thus, would ramp up in FY23-FY24E, pushing margins up from present ~8.2% for foreign subsidiaries. BHFC has an orderbook of Rs15bn under EVs/hybrids with ~80% of German/US order addition being for EVs.

* Core capex growth to be ~Rs3.5-4bn in FY23E with investment in aluminium forging capacity augmentation and investment for EV components to add on to that with overall capex outlook being pretty much fluid depending on demand growth outlook.

* Working capital inflated this year due to container issues and elevated metal prices. This should normalise down back to ~21-22% of revenue from ~25% in FY22.

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