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Q2 EBITDA slightly above estimates; Global CV outlook remains muted

Bharat Forge’s Q2FY23 revenue grew by 16% YoY (3-yr CAGR at 14%) to Rs18.6bn, 11% above our estimates, owing to inventory build-up with CV customers, execution of new orders in global PVs, and higher defense revenue. EBITDA declined by 1% (3- yr CAGR at 15%) to Rs4.5bn, 3% above our estimate, led by higher revenue. Our earnings estimates for FY23-25E are broadly unchanged, despite the increase in revenue assumptions by 3-5%, owing to a reduction in operating margins. Going forward, a muted outlook is expected by Paccar (OEM), Volvo (OEM), and Americas Commercial Transportation for North America Class 8 trucks for CY23/CY24 and Europe heavy trucks for CY23. Considering subdued global CV outlook and limited upside potential, we retain HOLD with a Dec-23 TP of Rs820 (Rs785 earlier), based on 24x P/E for standalone and 13x P/E for subsidiaries. The increase in TP is due to rollover to Dec-23 valuation (Sep-23 earlier) and higher profitability for subsidiaries because of the recent order-win relating to artillery guns. Key upside risks: Higherthan-expected growth in major segments, new order-wins, and favourable commodity/currency rates.

Q2 EBITDA slightly above estimates: Revenue grew by 16% YoY (3-yr CAGR at 14%) to Rs18.6bn (est.: Rs16.8bn), above estimates on account of inventory build-up with CV customers, execution of new orders in global PVs, and higher defense revenue (armored vehicle orders to be executed mostly over Q2 and Q3). EBITDA declined by 1% (3-yr CAGR at 15%) to Rs4.5bn, 3% above estimates (est.: Rs4.4bn), owing to higher revenue. EBITDA margin contracted by 410bps YoY (-190bps QoQ) to 24.3% (est.: 26.1%), below estimates mainly due to lower gross margin. Gross margin declined by 470bps YoY (-310bps QoQ) to 55.6% due to higher input cost, adverse mix, and one-off cost of Rs130mn related to defense penalties. Other income grew by 48% to Rs477mn. Accordingly, adjusted PAT declined by 5% (3-yr CAGR at +6%) to Rs2.68bn (est.: Rs2.49bn), above estimates due to higher operating profit and other income. Adjusted PBT loss of subsidiaries widened to Rs1.2bn vs. loss of Rs596mn last year, as a result of cost pressures in Europe and startup costs at US Aluminum plant. What we liked: Healthy revenue traction in defense/PV segments. What we did not like: 1) Weak gross margin performance. 2) Increased losses in Europe subsidiaries.

Earnings call KTAs: 1) North America Class 8 outlook: Management expects steady production to continue at current levels (close to 28,000-29,000 production) in the subsequent months. 2) Europe HCV outlook: Demand is flat currently and could be flat or negative in CY23. 3) Domestic revenue is expected to be lower sequentially in Q3FY23; however, growth is expected to continue. 4) Defense: For export artillery guns order, the company would invest Rs300-400mn for the assembly facility. Forging-related revenue would be accounted in standalone. 5) Overseas subsidiaries: Expect margin improvement from Q1FY24. 6) Expect JS Autocast (subsidiary) revenue to grow by 10-15% in FY23, and the uptrend is expected to persist with a 20% CAGR over the next few years. Management expects double-digit margins in the next 2-3 years. 7) Sanghvi Forgings’ (subsidiary) annualized revenue rate has almost doubled to Rs1bn post the acquisition. Management expects margin of ~20% going ahead.

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