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Margin performance commendable

Bharat Forge’s (BHFC) Q1FY22 earnings were a beat on consensus estimates as standalone and consolidated EBITDA margins came in at 28.5% and 21.4%, up 106bps and 92bps QoQ respectively. The beat was driven by 229bps QoQ improvement in gross margin which was driven by revival in the oil and gas (O&G) sector and higher exports (revenue contribution: 67% in Q1).

In exports, revenues from the US region grew fastest (~31% QoQ) while that from EU was up 16%. We expect improvement in growth outlook on existing businesses (CV, industrial) from the US government’s stimulus as well as ramp-up of aluminium forging orders.

New plants ramp-up in FY23 and their reaching peak utilisation in FY24, could lead to improved operating efficiencies and FCF generation (FY23E:Rs15.5bn). However, current valuations remain rich (EV/EBITDA and P/E: 17x and 31x FY23E respectively). Maintain HOLD

* Key highlights of the quarter: Standalone revenues improved 4.9% QoQ to ~Rs13.7bn (O&G business rose ~Rs1bn QoQ) while EBITDA margin was up 106bps to 28.5%. Gross margins rose 229bps to 62% due to superior mix despite RM price inflation (Rs300mn steel price increase). Standalone PAT reported a profit of ~Rs2.3bn. Company also reported an exceptional item of Rs0.62bn towards VRS of unionised employees. On the overseas subsidiaries, EBITDA margins remained healthy at 11.7% (up 110bps QoQ).

* Key takeaways from earnings call: Management indicated: a) O&G segment is witnessing strong demand with Rs1.5bn in revenues (Q4: Rs0.45mn); b) BHFL has completed acquisition of Sanghvi Forgings (SFEL) for Rs770mn; BHFC is likely to incur Rs200mn-250mn cost for debottlenecking as the SFEL facility is expected to breakeven in Q2FY22 and be profitable from Q3 onwards; c) SFEL is likely to help BHFC triple its capacity in two years and achieve peak revenue potential of Rs5bn6bn with scope for expansion; d) Class-8 truck orders were hit by semiconductor chip shortage; however, production is catching up with demand and is expected to reach ~300k units in FY22E; US infra stimulus is likely to further boost demand; e) company has currently at a 10-month backlog on orders (class-8 trucks); f) aluminium business is expected to double revenues per year over next 2.0-2.5 years even as new line in US is likely to hit peak production in FY24 (US$80mn-85mn revenues); and g) capex is expected to be in the range of Rs2.5bn-3bn for FY22.

* Maintain HOLD: We upgrade our earnings on sharp improvement in growth outlook led by industrials and higher FCF generation. We raise our EPS estimates for FY22E/FY23E by ~25%/13% respectively and also raise our target multiple to 30x (vs 28x earlier) FY23E EPS and add Rs44/share (earlier: Rs45/share) for fair value (DCF basis) of defence business (link), to arrive at a revised target price of Rs853 (earlier: Rs712). Maintain HOLD.

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