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Margins resilience led by exports and industrials

Bharat Forge’s (BHFC) Q2FY22 earnings were in line with consensus estimates as standalone and consolidated EBITDA margins came in at 28.3% and 20%, up 1,058bps and 792bps YoY, respectively. Revenues rose on the back of strong industrial sector performance (domestic and exports) amidst semiconductor challenges in the automotive division. BHFC is entering strong growth cycle with multiple drivers: a) capex recovery in construction segment, b) global commodity upcycle (e.g. crude oil), c) global and domestic truck cycle recovery, d) electrification, and e) potential defence orders. We believe the near-term weakness (due to semiconductor shortages) is a sideshow and the opportunity to play the global cyclical recovery theme is the key. Valuations turn fair at 21x FY24E EPS; ~5% FCF yield. Upgrade to BUY from Hold.

* Key highlights of the quarter: Standalone revenue improved 82.3% YoY (volume growth of ~40% at 57k MT) to ~Rs16bn while EBITDA margin was up 1058bps to 28.3% supported by superior export mix (up ~690bps) along with lower other expenses (down 933bps) and employee costs (down 463bps). Gross margins declined 338bps to 60.3% due to RM price inflation and adverse freight costs. Standalone PAT stood at ~Rs2.8bn. Overseas subsidiaries continue to perform well and reported ~144% YoY jump in revenue at Rs8.5bn while clocking EBITDA margins of 10.8%.

* Key takeaways from earnings call: Management indicated a) O&G segment clocked Rs2bn in revenues (Q1: Rs1.5bn; Q4: Rs0.45mn); and shale fracking for gas is improving MoM; b) Sanghvi Forgings (SFEL) has turned PBIT positive and is expected to provide US$110-120mn revenue opportunity from domestic industrial segment; c) BHFC has received 100k aluminium forged medical grade cylinder order to be completed by Q3 and is expected to create a long term business opportunity around the same; d) on EVs: company has clocked Rs100-150mn in domestic revenues so far and currently in power electronics segment clocks revenues of ~EUR12-15mn; it has started supplying 650V-800V power electronics products for industrial customers and 48V-80V products for automotive segment; e) aluminium forging business is expected to surpass US$250mn from current US$70mn over the next 2-2.5 years; and f) growth capex is expected to be US$75mn for overseas subs and Rs1bn for India business in FY22.

* Upgrade to BUY: We introduce FY24E and raise our EPS estimates for FY22E/FY23E by ~10%/3% on the back of improvement in growth outlook and profitability. As we rollover into mid-cycle (Sep’23E) we prune our target multiple to 27x (vs 30x earlier) and add Rs46/share (earlier: Rs44/share) for fair value (DCF basis) for the defence (ATAGS opportunity) business, to arrive at a revised target price of Rs915 (earlier: Rs853). Upgrade to BUY from Hold.

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