Defence business to drive growth for Bharat Forge

Since its results for the first quarter of the 2023-24 financial year (Q1FY24) earlier this month, the stock of auto component major Bharat Forge is up nearly 15 per cent and hit its all-time high in the process.

The recent gains have extended the returns over the last three months to over 34 per cent.

After a strong Q1 performance which beat expectations, brokerages had revised their earnings estimates upwards to factor in the improved outlook.

The company recently announced that Kalyani Strategic Systems, its wholly owned defence subsidiary, won two export orders worth Rs 850 crore for supply of components and armoured vehicle chassis.

The orders are to be executed over the next 18 months.

The company had highlighted after the Q1 results about the scaling up of defence revenues which accounted for 6 per cent of revenues.

The company seeks to take it up to 10 per cent in FY24.

The company had won a new export order of Rs 280 crore in Q1, taking its total order book to Rs 2,300 crore.

The addition of recent orders would take up the total order book thus far to about Rs 3,100 crore.

Say Kapil Singh and Siddhartha Bera of Nomura Research, “Consistent order wins from multiple geographies and for different products indicates that Bharat Forge is on an exponential growth path in defence exports.

"It is developing several new products like vehicles, artillery systems, components, naval solutions and unmanned systems.

"Thus, we see the potential for it to transform into a leading exporter of defence components and systems from India.”

The company expects domestic defence orders to gain further traction with the advanced towed artillery gun system which should reflect in Q4FY24.

Another trigger is the improvement in the health of the overseas subsidiaries.

Of the company’s loss-making foreign subsidiaries, the European entities have achieved 50 per cent capacity utilisation and were profitable at the operating level.

The US subsidiaries are expected to achieve similar utilisation by Q4 FY24.

Say analysts led by Joseph George of IIFL Research, “The worst seems to be behind for overseas subsidiaries. Capacity utilisation of the plants are improving and operating expenses are likely to moderate.”

With the improvement in subsidiaries, the company is eyeing margins in high teens on a consolidated basis as compared to 14 per cent in FY23 and 15 per cent in Q1FY24.

It is a mixed outlook for the largest chunk of firm’s business — trucks or medium and heavy commercial vehicles which accounted for 37 per cent of revenues.

While in the near term, both India and the US truck business are expected to remain strong, JP Morgan expects the US business to witness some pressure in the 2024 calendar year (CY24) before witnessing a recovery in CY25/26.

The brokerage has an ‘overweight’ rating on the stock on the back of better than expected traction in defence and industrial revenues — which is reducing the dependence on the cyclical truck business — and faster than expected turnaround in subsidiary profitability which is also geared towards new structural growth areas such as aluminium forging, renewables and defence.

UBS Research has a ‘buy’ rating for similar reasons and expects new businesses such as defence, aluminium forging, and castings to significantly ramp up driving strong medium term growth.

At the current price, the stock trades at 26 times its FY25 earnings. Given the sharp run up, investors should await a meaningful correction before considering the stock.

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