Diversification’s a positive; FY19/20e EPS cut 4/10%; downgraded to ‘Reduce’ with TP revised to Rs 460
Post our downgrade of Bharat Forge (BHFC) in October, 2018, the exports outlook has deteriorated further as worsening macro data raises risks to our FY20 growth estimates. The recent dip in Class 8 order intake (down 14% y-o-y and 36% m-o-m in November) and worsening US PMI data were negative surprises. Hence, we revise down FY19/FY20e EPS 4/10% building in a sharper drop in exports (CVs and industrial) given rising risks to exports even as the company sustains its impressive business diversification drive. Moreover, we perceive higher risk of consensus downgrades as exports outlook gets bleaker.
Hence, we cut our target price to Rs 460 (Rs 630 earlier) in line with the revised earnings and upper-end of down cycle PE of 18x (22x earlier). Downgrade to Reduce.
Weakening exports outlook puts consensus earnings at risk
BHFC’s earnings are highly sensitive to exports. After six months of strong order intake (45k), Class 8 data for November, 2018 tapered to 28k (down 14% y-o-y and 36% m-o-m in November). Additionally, worsening US PMI data , in our view, poses downside risk to FY20 consensus estimates.
Diversification benefits long term, but gradual
BHFC has successfully scaled up several new businesses—defence ($50 mn), aerospace & PV exports (Rs 4 bn)—over the past two-three years. However, their contribution is expected to rise gradually and we believe BHFC’s sensitivity to CV and industrial exports continues to remain high (60% of standalone revenue). Additionally, weakness in domestic CV cycle poses downside risk to our estimates.
Outlook & valuations: Cyclical challenges; downgrade to ‘REDUCE’
We reaffirm our confidence in management’s prescience in targeting new revenue streams. However, we perceive near to medium term risk of de-rating as United States’ growth continues to taper with the cycle turning milder over ensuing quarters. Hence, we downgrade to Reduce from ‘HOLD’. We retain ‘Sector Performer’ rating. Sustenance of global growth and pre-buying ahead of new emission norms in the domestic market pose upside risks to our estimates.