9 December 2015

Update | Sector: Automobiles

Bharat Forge

Jinesh Gandhi (Jinesh@MotilalOswal.com); +91 22 3982 5416 Jay Shah (Jay.Shah@MotilalOswal.com); +91 22 3078 4701

BSE SENSEX S&P CNX CMP: INR793 TP: INR1,033 (+30%) Buy 25,036 7,613 Bloomberg BHFC IN Equity Shares (m) 232.8 M.Cap. (INR b) / (USD b) 184.7/2.8

52-Week Range (INR) 1,363 /773 1, 6, 12 Rel. Per (%) -4/-23/-6

Avg Val (INR m) 1,247 Free float (%) 53.3

Financials & Valuation (INR Billion) Y/E MAR 2015 2016E 2017E

Net Sales 76.2 82.8 95.5

EBITDA 14.4 16.5 19.3 Adj PAT 7.4 8.3 10.7 EPS (INR) 31.5 35.7 45.9

Gr. (%) 64.8 13.1 28.6 BV/Sh.(INR) 147.9 172.8 204.2 RoE (%) 24.1 22.2 24.3

RoCE (%) 22.0 23.3 26.2 P/E (x) 25.1 22.2 17.3 P/BV (X) 5.4 4.6 3.9

Estimate change

TP change

Rating change

PVs, Railways and Aerospace to drive revenue growth Focusing on new components in CVs, import substitution in non-Autos We attended BHFC’s analyst meet. While the management acknowledged short-term challenges, it also mentioned that few reports might be presenting an exaggerated view. New customers and ramp-up in new businesses would dilute the impact of weak US CV and O&G/mining. BHFC continues to focus on technology and intends to transform from a component supplier to a solution provider. Our key takeaways:

CV business The management guided 15% decline in US HCV demand to ~270k units and

marginal growth in EU HCV demand in CY16. Globally, it expects CV demand to decline ~6% in CY16 and ~3% in CY17.

Increase in US Class-8 truck industry channel inventory from 2 months to 3.5 months would be gradually corrected in CY16; the management has guided ~15% decline in volumes.

BHFC is gaining market share in global CV forgings, as it has added new customers like PACCAR in US and DAF (subsidiary of PACCAR) in EU.

In the last 1.5 years, BHFC has developed capabilities in truck transmission parts, which should improve its content per truck considerably and drive growth in the CV segment from FY17.

PV business The PV segment offers huge opportunity; this would be multiple times the

opportunity in the CV segment. BHFC has set a target of increasing revenue contribution from PVs to 15% of

sales (v/s 5% currently) over 18-24 months. It plans to achieve this target by increasing market share in India and globally by adding new customers.

BHFC is focusing is on the transmission segment, as the market is shifting from 5-speed to 9-speed automatic gearboxes. It is an opportunity for BHFC due to limited capacity globally on the transmission front. Of ~100m PVs sold annually, ~40m PVs would undergo transmission change.

It expects supply of components for transmission to start from FY17.

Defense business With the government promoting Make in India, the Defense segment, which

currently imports heavily, presents a large opportunity for domestic suppliers. BHFC is already supplying components and sub-components to Indian

Defense. It classifies defense supplies into two parts: (1) revenue items – already getting orders; expect revenues from next year, and (2) capital items – four artillery programs, of which two should get validated by next year. If even one artillery program is converted, the opportunity would be INR2b-3b over 15-20 years.

Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.

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Bharat Forge

Group entity, Kalyani Strategic Systems (KSS) would be the front end for artillery programs. However, BHFC would supply all components to KSS for defense.

Apart from the government ordnance factory, BHFC is the only company in India in artillery forgings.

Aerospace business BHFC currently has four contracts from marquee customers and would soon

announce a large contract. It aims to have revenues of USD100m from the Aerospace business in five

years. Hindustan Aeronautics (HAL) imports INR10b of forging parts annually for

maintenance. BHFC is working with HAL to substitute imports of forging components and has received ~70% of approvals (especially for Russian inputs). BHFC is already approved by other aerospace companies for these components.

Boeing is currently creating an ecosystem in India and BHFC is the only forging company it is working with.

Railways business Approvals in place for engine components with OEMs are resulting in steady

order flow. BHFC has become the main supplier to Indian Railways for all key components

of diesel locomotive engines. It supplies components to GE in the US and is likely to supply to GE in India too, as it sets up a locomotive factory in India.

Other takeaways In the Oil & Gas business, BHFC intends to start supplies to the sub-sea

market, where it has no market share. Also, it is looking at adding more value to current products by providing more processing activities.

It is already supplying gear components for wind turbines, and is aiming to move to machined components from forged components.

BHFC is looking at M&A only if new technology can be brought in. It is working on new technologies like 3D printing, metal injection molding

and nano technology to make conventional products better. For FY16, BHFC expects flattish standalone revenues. We believe its FY18

target of ~INR70b could be challenging. Standalone EBITDA margins are sustainable at 29-30%. Subsidiaries should

make 10-12% EBITDA margins from next year. BHFC is targeting to improve return ratios – RoCE and RoNW of over 20%. It expects positive momentum for all sectors (CV, PV, Construction, Mining,

and Power) in India. In North America, it expects negative momentum for CV, Oil & Gas, Construction, Mining and Power, and positive momentum for PV and Aerospace. In EU, it expects positive momentum for CV, PV, Aerospace and Power, and negative momentum for Oil & Gas, Construction and Mining.

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Exhibit 1: Global truck industry outlook Particulars ('000 Units) 2014 2015 2016E 2017E North America 290 320 270 245 Europe 225 251 264 268 Brazil 93 45 45 50 Major Markets 608 616 579 563 % Change 1.3% -6% -3%

Source: Company, MOSL

Exhibit 2: State of markets for BHFC

Source: Company

Exhibit 3: BHFC’s strategic goals for 2018

Source: Company, MOSL

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Bharat Forge

Valuation and view Has emerged stronger, leaner and healthier from the downcycle BHFC has broadened its revenue stream by entering new segments (non-auto) and global markets. The share of auto business has declined from ~80% in FY07 to ~54% in FY15 and the share of India has reduced from ~60% to ~40%. Further, it has increased value-addition by focusing on machined components, the contribution of which has increased to ~51% in FY14, boosting realizations and margins. It has improved its balance sheet by focusing on controlling debt through lower capex, resulting in fall in net debt-equity to ~0.5x/0.4x by FY16/FY17. Auto business – awaiting CV cycle recovery; focusing on PVs Benefit of US Class-8 demand improvement, driven by pre-buying before emission norm changes and gradual recovery in the EU would reflect in FY16. BHFC is a clean play on the domestic CV cycle recovery, with over 60% market share in M&HCV components. The PV segment is a focus area for BHFC, as this segment offers an opportunity size 4x that of CVs. Non-auto business – play on investment cycle recovery The non-auto segment offers significant growth potential, as it is much larger than the auto segment. BHFC is targeting ~60% of its standalone revenues from the non-auto segment, up from the current ~49%. Its partnerships with global players (Alstom, Areva, David Brown, etc) bear testimony to its globally cost competitive engineering/manufacturing capabilities. BHFC’s increasing penetration with existing and new customers, coupled with economic stability in the international market and investment cycle recovery in India, would drive ~13% revenue CAGR in the non-auto segment over FY15-18E. Multiple levers to support/improve profitability We expect consolidated revenues to grow at a CAGR of ~14% over FY15-17. EBITDA margin should expand ~130bp to 20.2%, driven by higher exports from India, rising contribution from non-auto business and machined components, and operating leverage. We estimate cumulative FCF generation of ~INR34b during FY15-18, enabling balance sheet turning to net cash of ~INR6b (v/s ~INR11.8b net debt). Consolidated RoE would improve from 24.1% in FY15 to ~26.5% in FY18 – the highest since FY07. Valuations and view The stock trades at 22.2x/17.3x FY16/FY17E consolidated EPS are attractive for a global leader in forgings. Maintain Buy with a target price of ~INR1,033.

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Exhibit 4: Valuations at historical average, reflecting slowdown in business

Source: MOSL

Source: MOSL

Exhibit 5: Comparative valuations CMP * Rating TP P/E (x) EV/EBITDA (x) RoE (%) RoCE (%) Auto OEM's (INR) (INR) FY16E FY17E FY16E FY17E FY16E FY17E FY16E FY17E Bajaj Auto 2,390 Buy 3,118 18.2 14.3 11.2 9.1 33.2 36.1 47.6 48.3 Hero MotoCorp 2,547 Buy 2,862 16.2 14.2 10.3 9.2 43.3 40.5 60.4 55.3 TVS Motor 270 Buy 326 27.8 16.9 16.7 10.9 25.5 33.3 24.3 32.7 M&M 1,313 Neutral 1,286 20.3 16.3 15.6 13.5 16.0 15.9 17.6 17.9 Maruti Suzuki 4,477 Buy 5,059 26.3 18.8 12.9 10.1 18.3 21.8 25.6 29.4 Tata Motors 394 Buy 471 11.6 8.7 4.0 3.3 17.5 18.7 16.2 16.8 Ashok Leyland 87 Buy 100 23.3 12.3 11.2 6.9 19.3 30.4 20.3 31.1 Eicher Motors# 15,724 Buy 21,820 45.2 28.2 24.9 16.2 34.0 40.8 36.0 46.8 Auto Ancillaries Bharat Forge 793 Buy 1,033 22.2 17.3 11.8 9.9 22.2 24.3 23.3 26.2 Exide Industries 137 Buy 183 19.0 15.1 11.4 9.3 13.7 15.4 18.7 19.9 Amara Raja Batteries 839 Buy 1,032 28.0 20.3 16.7 12.5 25.3 25.3 34.8 33.5 BOSCH 18,340 Buy 23,013 45.5 33.1 30.0 22.5 16.2 19.4 23.8 27.4

# Nos. are on CY basis Source: Company, MOSL

20.1 25.3 19.8

30.8

0

40

80

120

160

Nov

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Jan-

02

Mar

-03

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Jul-0

5

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06

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-07

Dec

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10

Apr-1

1

May

-12

Jul-1

3

Sep-

14

Nov

-15

P/E (x) 15 Yrs Avg(x)5 Yrs Avg(x) 10 Yrs Avg(x)

4.4

3.9 3.6

3.8

0.0

2.0

4.0

6.0

8.0

10.0

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-12

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P/B (x) 15 Yrs Avg(x)5 Yrs Avg(x) 10 Yrs Avg(x)

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Key operating metrics

Exhibit 6: Revenue model INR M FY11 FY12 FY13 FY14 FY15 FY16E FY17E Autos 17,018 20,411 17,541 18,333 22,970 26,372 30,664 % of total revenues 64 61 60 59 53 59 60 CV 14,786 18,013 14,837 15,930 19,529 22,325 25,334 % of total revenues 55 54 51 51 45 50 50 PV 2,232 2,398 2,704 2,403 3,441 4,047 5,330 % of total revenues 8 7 9 8 8 9 10 Non-Autos 9,770 13,190 11,455 12,827 20,045 18,148 20,333 % of total revenues 36 39 40 41 47 41 40 Market mix (net sales incl Op Income)

India 17,278 19,514 15,645 15,511 18,273 20,248 24,453 % of total revenues 59 53 50 46 40 43 45 Growth (%) 51 13 -20 -1 18 11 21 Exports 12,195 17,346 15,867 18,483 27,207 27,112 30,366 % of total revenues 41 47 50 54 60 57 55 Growth (%) 72 42 -9 16 47 0 12 USA 5,774 8,083 8,933 9,179 17,413 19,851 22,828 % of total revenues 20 22 28 27 38 42 42 Growth (%) 43 40 11 3 90 14 15 EU 5,380 7,751 5,862 7,848 8,447 9,123 10,400 % of total revenues 18 21 19 23 19 19 19 Growth (%) 90 44 -24 34 8 8 14 Others 1,041 1,512 1,072 1,456 1,347 -1,861 -2,863 % of total revenues 4 4 3 4 3 -4 -5 Growth (%) 343 45 -29 36 -7 -238 54 Total Net Op Revenues 29,473 36,860 31,512 33,993 45,480 47,361 54,819 Growth (%) 59 25 -15 8 34 4 16 Subsidiary Revenues 21,396 25,931 20,153 33,166 30,767 35,472 40,706 Growth (%) 45 21 -22 65 -7 15 15 Net Consolidated Revenues 50,869 62,791 51,666 67,158 76,247 82,833 95,525 Growth (%) 53 23 -18 30 14 9 15 S/A EBITDA margins (%) 24.3 24.8 22.7 25.4 29.2 29.8 29.4 Consol EBITDA margins (%) 15.4 15.9 15.3 15.3 18.9 19.9 20.2 Consol EPS (INR) 13.0 18.0 11.9 19.1 31.5 35.7 45.9 Growth (%) 1,615.8 39.1 -34.2 61.3 64.8 13.1 28.6

Source: Company, MOSL

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Financials and valuations

Consolidated - Income Statement (INR Million) Y/E March FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E Net Sales 33,276 50,869 62,791 51,666 67,158 76,247 82,833 95,525 Change (%) -30.3 52.9 23.4 -17.7 30.0 13.5 8.6 15.3 Total Expenditure 29,891 43,017 52,826 43,750 56,887 61,840 66,331 76,236

% of Sales 89.8 84.6 84.1 84.7 84.7 81.1 80.1 79.8 EBITDA 3,385 7,852 9,964 7,915 10,272 14,407 16,502 19,289 Margin (%) 10.2 15.4 15.9 15.3 15.3 18.9 19.9 20.2 Depreciation 2,451 2,550 3,022 3,195 3,572 3,624 3,706 4,066 EBIT 934 5,302 6,943 4,720 6,700 10,783 12,796 15,223 Int. and Finance Charges 1,303 1,534 1,860 1,672 1,692 1,356 1,071 1,027 Other Income - Rec. 511 675 915 1,121 1,249 1,368 1,201 1,672 PBT bef. EO Exp. 142 4,442 5,998 4,169 6,258 10,794 12,926 15,868 EO Expense/(Income) 787 77 0 -366 -1,037 -428 0 0 PBT after EO Exp. -645 4,365 5,998 4,535 7,295 11,222 12,926 15,868 Current Tax 119 1,397 1,796 1,529 2,100 3,587 4,620 5,182 Deferred Tax 0 0 0 0 0 0 0 0 Tax Rate (%) -18.4 32.0 29.9 33.7 28.8 32.0 35.7 32.7 Reported PAT -764 2,969 4,202 3,006 5,195 7,635 8,306 10,685 Less: Mionrity Interest -130 67 72 -41 -28 -30 0 0 Net Profit 299 2,954 4,130 2,804 4,485 7,374 8,306 10,685

Consolidated - Balance Sheet (INR Million) Y/E March FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E Equity Share Capital 445 466 466 466 466 466 466 466 Total Reserves 14,185 19,064 21,373 22,098 26,367 33,976 39,763 47,090 Net Worth 14,630 19,529 21,839 22,564 26,832 34,442 40,229 47,555 Minority Interest 783 1,542 1,957 1,643 170 20 20 20 Deferred Liabilities 851 1,321 886 1,345 1,645 1,638 1,638 1,638 Total Loans 22,527 19,014 27,835 28,249 25,612 23,645 21,645 19,645 Capital Employed 38,791 41,406 52,517 53,800 54,259 59,745 63,532 68,859 Gross Block 41,344 45,010 49,798 56,452 53,945 56,984 68,570 74,070 Less: Accum. Deprn. 17,267 20,383 23,270 26,807 28,604 30,697 34,402 38,469 Net Fixed Assets 24,078 24,627 26,527 29,645 25,340 26,287 34,167 35,601 Capital WIP 1,987 2,007 5,168 6,324 5,827 8,586 1,000 1,000 Total Investments 2,737 2,614 4,450 4,160 8,012 4,955 4,955 4,955 Curr. Assets, Loans&Adv. 24,171 27,501 37,197 34,266 36,166 42,552 49,648 57,562 Inventory 6,575 8,115 10,961 11,320 10,386 10,339 12,482 14,394 Account Receivables 5,044 7,539 8,134 6,114 8,660 8,535 10,212 11,777 Cash and Bank Balance 5,977 3,964 6,337 5,554 4,227 6,820 11,546 13,621 Loans and Advances 6,576 7,883 11,765 11,278 12,893 16,858 15,409 17,770 Curr. Liability & Prov. 14,182 15,342 20,825 20,594 21,086 22,634 26,238 30,259 Creditors 7,736 9,709 11,789 9,511 10,554 11,016 13,616 15,703 Other Current Liabilities 3,428 3,411 6,462 8,950 7,526 8,632 9,378 10,814 Provisions 3,018 2,222 2,575 2,133 3,006 2,987 3,244 3,742 Net Current Assets 9,989 12,159 16,372 13,672 15,080 19,917 23,410 27,303 Appl. of Funds 38,791 41,406 52,517 53,800 54,259 59,745 63,532 68,859 E: MOSL Estimates; * Adjusted for treasury stocks

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Financials and valuations

Ratios Y/E March FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E Basic (INR) *

EPS 0.8 13.0 18.0 11.9 19.1 31.5 35.7 45.9 Cash EPS 11.8 23.9 31.0 25.6 34.5 47.1 51.6 63.4 BV/Share 65.7 83.9 93.8 96.9 115.2 147.9 172.8 204.2 DPS 1.0 3.5 4.0 3.4 4.5 7.5 9.0 12.0 Payout (%) -35.5 31.9 25.8 30.7 23.6 27.5 30.3 31.4 Valuation (x) *

P/E 41.4 25.1 22.2 17.3 Cash P/E 23.0 16.8 15.4 12.5 P/BV 6.9 5.4 4.6 3.9 EV/Sales 3.1 2.6 2.4 2.0 EV/EBITDA 20.1 14.0 11.8 9.9 Dividend Yield (%) 0.6 0.9 1.1 1.5 Return Ratios (%)

RoE 1.9 17.3 20.0 12.6 18.2 24.1 22.2 24.3 RoCE 3.8 15.8 17.8 11.6 15.4 22.0 23.3 26.2 Working Capital Ratios

Fixed Asset Turnover (x) 0.8 1.1 1.3 0.9 1.2 1.3 1.2 1.3 Inventory (Days) 72 58 64 80 56 49 55 55 Debtor (Days) 54 54 47 43 47 41 45 45 Creditor (Days) 85 70 69 67 57 53 60 60 Working Capital Turnover (Days) 44 59 58 57 59 63 52 52 Leverage Ratio (x)

Debt/Equity 1.5 1.0 1.3 1.3 1.0 0.7 0.5 0.4 * Adjusted for treasury stocks

Consolidated - Cash Flow Statement (INR Million) Y/E March FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E Operating PBT -645 4,368 5,995 3,919 7,322 11,223 12,796 15,223 Depreciation 2,451 2,548 3,022 3,360 3,571 3,624 3,706 4,066 Other income 1,148 1,465 2,373 2,437 70 1,358 1,201 1,672 Direct Taxes Paid -494 -567 -1,710 -1,193 -2,113 -4,088 -4,620 -5,182 (Inc)/Dec in WC 3,210 -4,090 -2,307 -385 -1,629 -1,240 1,233 -1,818 CF from Operations 5,670 3,724 7,372 8,139 7,222 10,877 14,316 13,961 CF from Operating incl EO 5,670 3,724 7,372 8,139 7,222 10,877 14,316 13,961 (inc)/dec in FA -2,163 -3,986 -6,903 -5,288 -5,843 -7,113 -4,000 -5,500 Free Cash Flow 3,507 -262 469 2,851 1,379 3,764 10,316 8,461 (Pur)/Sale of Investments -2,246 -334 -3,940 2,391 3,343 1,913 0 0 CF from Investments -4,409 -4,320 -10,843 -2,896 -2,500 -5,201 -4,000 -5,500 Inc/(Dec) in Debt 1,880 -3,541 7,902 -454 -3,477 -621 -2,000 -2,000 Interest Paid -1,336 -1,487 -1,940 -2,111 -1,701 -1,460 -1,071 -1,027 Dividend Paid -261 -272 -1,343 -949 -1,221 -1,519 -2,519 -3,359 CF from Fin. Activity -168 -1,416 4,619 -3,513 -6,399 -3,599 -5,590 -6,386 Inc/Dec of Cash 1,093 -2,012 1,148 1,729 -1,677 2,077 4,726 2,075 Add: Beginning Balance 4,883 5,977 1,197 2,345 4,074 2,397 4,474 9,200 Closing Balance 5,977 3,964 2,345 4,074 2,397 4,474 9,200 11,275

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Corporate profile: Bharat Forge

Exhibit 8: Shareholding pattern (%) Sep-15 Jun-15 Sep-14

Promoter 46.7 46.7 46.7

DII 13.9 13.6 15.2

FII 18.0 18.5 16.7

Others 21.3 21.2 21.3

Note: FII Includes depository receipts

Exhibit 9: Top holders Holder Name % Holding

Life Insurance Corporation Of India 3.2 Reliance Capital Trustee Company Ltd 2.7 Copthall Mauritius Investment Ltd 1.3 Amrit Petroleums Pvt Ltd 1.2

Exhibit 10: Top management

Name Designation

B N Kalyani Chairman & Managing Director

G K Agarwal Deputy Managing Director

Amit B Kalyani Executive Director

S E Tandale Executive Director

B P Kalyani Executive Director

Kishore Saletore CFO

Exhibit 11: Directors Name Name

B N Kalyani Vimal Bhandari*

G K Agarwal Lalita D Gupte*

P G Pawar* P C Bhalerao

S M Thakore* S E Tandale

T Mukherjee* B P Kalyani

Naresh Narad* Amit B Kalyani

P H Ravikumar* Sunil K Chaturvedi

*Independent

Exhibit 12: Auditors

Name Type

S R Batliboi & Co LLP Statutory Dhananjay V Joshi & Associates Cost Auditor

Exhibit 13: MOSL forecast v/s consensus EPS

(INR) MOSL

forecast Consensus

forecast Variation

(%)

FY16 35.7 36.6 -2.3

FY17 45.9 45.8 0.3

Company description BHFC, part of USD2.5b Kalyani group, is global leader in forging business having transcontinental presence across India, Germany and Sweden, serving several sectors including automotive, power, oil and gas, construction & mining, locomotive, marine and aerospace.

Exhibit 7: Sensex rebased

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N O T E S

COMPANIES

COMPANIES

SECTOR UPDATES

AUTO GALLERY

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