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Expanding opportunities with diversification

Well poised to tap opportunities in growing industrials and exports market

Happy Forgings (HFL) is a Ludhiana-based company specializing in diversified forging and machining services. With over four decades of industry experience, it manufactures and delivers top-quality, intricate components. It is ranked as the fourth largest engineering-led manufacturer in India for complex and safety-critical, heavy forged, and high-precision machined components. The company is well established within the industries and customer segments it serves, including a) heavy commercial vehicles (contributing to 41% of revenues), b) farm equipment (32%), c) off-highway vehicles (14%) and industrials (13%). Founded in 1979, HFL’s entire operations are based out of Ludhiana, Punjab, with three vertically integrated manufacturing facilities. HFL is well poised to grow in the coming years, led by expansion through increased capacities, product diversification, client acquisition, and emerging opportunities in industrials and exports. We expect 21%/25%/30% CAGR (over FY24E-26E) in standalone revenues/EBITDA/PAT and initiate coverage on the stock with a BUY rating and a TP of ~INR1,125 (based on 26x FY26E EPS).

Ability to deliver safety-critical, complex forged and machined products

* The company embarked on its journey by manufacturing basic forged components, evolving to produce complex and safety-critical products with closed tolerances. This transformation involved expanding capabilities in both light and heavy forging, as well as machining processes.

* It is the second company in India to have 14,000 ton forging press and among four companies to have 8,000 ton or higher press. It is a supplier to each of the top five Indian OEMs in the M&HCV industry and to four of the top five Indian OEMs in the farm equipment industry.

* The addition of the 14,000 ton press line in Q3FY23 has enabled the company to forge heavier, safety-critical parts, weighing up to 250Kgs, while also expanding its capabilities across various industries. Transitioning from solely a forgings player, HFL has now evolved into a fully machined player, with its machining mix increasing from ~53% in FY14 to ~84% in 9MFY24.

Well diversified mix to help offset cyclical uncertainty

* Over the years, HFL has successfully diversified its user industry across segments and customers. Its exports have now surged to 20% for 9MFY24 from just 13% in 9MFY23. Additionally, its Industrial segment contribution has increased to 13% for 9MFY24 from just 4% in 9MFY23.

* This diversified customer base has helped HFL reduce cyclicality to its core segments such as CVs and tractors. A case in point is the fact that despite weak demand in CVs (flat YoY) and tractors (-5% YoY) for 9MFY24, HFL has been able to post 13.5% YoY revenue growth, given a strong growth in the Industrials (non-tractor) segment.

New orders to drive near-term weakness in core Autos

* The major share of revenue for HFL is attributed to CV and Farm Equipment, constituting ~41% and 32%, respectively, in 9MFY24. While the near-term demand outlook for both the CV and tractor industry appears subdued, we believe structural drivers are in place for a recovery in FY25.

* It is pertinent to note that HFL has a healthy track-record of outperforming the core industry growth in the past. This is also highlighted from the fact that HFL’s revenue growth of 13.5% for YTDFY24, outpacing the significantly slower industry performance in both CV and tractor sectors for FY24YTD.

* These new order wins are expected to help drive its outperformance to its core focus auto and tractor segments. We expect HFL’s CV/tractor segment revenue to register a CAGR of ~10%/15% over FY24-26E, well ahead of our forecast for these segments.

Industrials/exports to be key growth driver for HFL

* Following the successful installation of its 14k MT press, HFL experienced a major influx of new order wins from the Industrial segment, leading to a substantial increase in the segment’s contribution to revenue, rising to 13% for YTDFY24 from just 4% in 9MFY23. HFL expects to ramp up the utilization of this press to 80% in the next three to four years from the current utilization of 40%.

* Further, given its relatively low manufacturing costs and favorable government policies to push localization, India is now emerging as the key beneficiary of this trend with many domestic vendors seeing renewed interest from global OEMs for sourcing from them.

* Like its peers, HFL is also emerging as one of the beneficiaries of this trend. This is evident from its ~60% share of exports in the order book. Accordingly, it expects exports contribution to rise to 25% by FY25 from the current 20% for YTDFY24.

Roadmap for strong growth in place

* We expect an 21% CAGR in standalone revenue over FY24E-26E, led by: i) stable growth in overall CV and farm equipment volumes, ii) addition of new capacities and products, iii) healthy order book, and iv) strategic initiatives to grow businesses such as industrials and exports.

* Profitability is likely to improve, led by increasing share of machining, improving utilization of high weight forgings press (14k tons), better product mix as the company grows in the industrials and exports division. This should also support EBITDA CAGR of ~25% over FY24-26, resulting in consistent increase in EBITDA margin to ~30.2% by FY26 vs 28.5% in FY24. Moreover, PAT is expected to register a CAGR of ~30%.

* Healthy profitability, coupled with improving utilizations, should bode well for free cash flows and improvement in return ratio. The company has guided for annualized capex of INR2b over the next few years. We expect aggregate operating cash flows/free cash flows of INR9.2b/INR3.2b over FY24-26E vs. INR3.4b/-1.2b over FY21-23.

* ROE and ROCE is expected to expand to 20.1%/19.2% by FY26E from 18.6%/17.1% in FY24E. The company repaid almost INR 1.5b worth of debt out of total fresh issue of IN4b, and now the debt stands at INR1.39b (vs. INR2.18b in FY23).

Valuation & view: Initiate coverage with a BUY rating

* On the back of new order wins in Auto segment, we expect HFL to continue to outperform core auto segments. Further, its healthy order wins in the Industrials/exports segments would help drive an improved mix. We expect HFL’s revenue/EBITDA/PAT CAGR of 21%/25%/30% over FY24-26E.

* Its superior financial track record relative to peers serves as a testament of its inherent operational efficiencies and is likely to be a key competitive advantage for HFL going forward. We initiate coverage on Happy Forgings with a BUY rating and a TP of INR1,125 (based on 26x FY26E EPS).

* Key downside risks: i) Lower-than-anticipated growth in underlying industries, ii) Faster EV adoption in CVs and tractors, iii) Macro headwinds in developed markets.

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