Bharat Forge's Q1FY20 results (Downgrade to Neutral) - Disappointing quarter; outlook remains hazy

Q1FY20 results

• Operating profit disappoints: BHFC’s reported PAT of Rs1.7bn (down 26% yoy) was 34% below estimates. The variance was on account of weaker than expected revenues / margin.
• Revenue declines amid weak demand: Revenues at Rs 13.5b (down 9% yoy) was 19% below estimates. While tonnage declined by 9% yoy, realisations were down 17% sequentially (due to the completion of a large defence related order in Q4FY19). Domestic revenue at Rs5.6bn declined by 7% yoy as a 31% yoy decline in M&HCV business more than offset growth in industrial/ passenger vehicle segments. Despite growth in the CV segment (+10% yoy), export revenues degrew (down 9%) as the industrial space declined 35%. The industrial segment was affected by customer destocking in the oil & gas segment. Adj. EBITDA margins came in at 26% (down by 300bps yoy, est 29%) - the lowest in last 6 years. While gross margins were broadly stable, the other expenses/staff costs rose sharply on negative operating leverage. The weak operating performance coupled with higher interest/depreciation costs led to a sharp decline in PAT.

Concall highlights: (a) Outlook on India CVs - Q2 volumes will be impacted by OEMs shutdown. (b) While orders from US Class 8 trucks are weakening on a high base, given the order backlog the company expects builds to grow by 5% in CY19 but expects 10% decline in CY20 (c) Inventory destocking in oil and gas export segment during last quarter was one time activity; revenues will normalise from quarter. (d) Construction for light weighing technology centre is complete, it is expected to be operational from Oct’19 (e)The management has a capex plan remains same at Rs12.5bn for FY20/21.

Key positives: None

Key negatives: Decline in the domestic CV / global industrial segments

Impact on financials: We cut FY20/21 estimates by 20%/22% respectively on weaker margins/revenues.

Valuation & view

BHFC has a dominant position in the forging space and a well-diversified portfolio. We also note that the company is entering the downcycle with a healthy balancesheet and limited capex requirements. However, with downcycle deepening across various segments – Class 8 trucks, domestic M&HCV and global industrials –we believe that the weak trends will impact the company’s growth prospects over the medium term.  Further, the anticipated growth from key new segments (railways, defence) seems to have been delayed. Downgrade the stock to Neutral with a target price of Rs 420 (18xFY21).