Bharat Forge's Q2FY20 results (Neutral) - Disappointing quarter; weak guidance

Q2FY20 results

• Operating profit disappoints: BHFC’s adjusted operating EBITDA at Rs3bn was 18% below estimates. The PAT of Rs2.5bn (up 8% yoy) though benefitted from a lower tax rate.
• Revenue declines amid weak demand: Revenues at Rs 12.6b (down 25% yoy; 6%qoq) was 11% below estimates. While tonnage declined by 23% yoy, realisations were down 2% yoy. Domestic business revenue at Rs4.5bn was down by 36% yoy majorly due to decline across segments with the commercial vehicle segment (-63% yoy) and industrial business showing sharp dips (-28% yoy). The decline in CV revenues has been sharper than the volume decline as the OEMs focussed on clearing BSVI inventory. Export revenues were also down by 18% led by weakness in the industrial activity even as new verticals are yet to take off. Adj. EBITDA margins came in at 23.9% (down by 446bps yoy, est 29%) - the lowest in last 6 years. The weak margins were largely on account of low gross margins (down 310bps yoy; 110 bps qoq). The company higher RM costs reflected a weaker product mix as well as a higher share of defence volumes (higher RM ratio but lower other expenses). On the positive side, other expenses declined (down 150bps qoq) on cost cutting measures). PAT at Rs2.5bn (+8% yoy), however benefitted from lower a lower tax rate.
• Concall highlights: (a) Outlook on domestic market – Q3 volumes will be slightly lower than Q3 due to OEMs shutdown however it is expected to improve in Q4 on back of the production of BS6 vehicles. (b) While orders from US Class 8 trucks are weakening on a high base, given the order backlog the company expects builds to decline by ~4% in CY19 but expects 20-25% decline in CY20 (c) Nellore plant is transferred under 100% subsidiary and it will come under new tax regime of 15%.  (d)The management has a capex plan remains same at Rs12.5bn for FY20/21.

Key positives: Lower other expenses

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

Impact on financials: We cut FY20/21 estimates by 18%/17% 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 balance sheet 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, defense) seems to have been delayed. Maintain Neutral with a target price of Rs 385 (20xFY21).