Bharat Forge Leveraged play on global revival PhillipCapital (India) Pvt. Ltd. AUTOMOBILES: Initiating Coverage 5 February 2014

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1 Bharat Forge Leveraged play on global revival PhillipCapital (India) Pvt. Ltd. AUTOMOBILES: Initiating Coverage 5 February 2014 Bharat Forge, one of the world s largest forgings company, has admirably maintained profitability in an elongated global downturn. With signs of a revival (particularly in the USA and Europe), we expect BHFC to benefit enormously from its high operating and financial leverage. Its improving product mix along with consolidation at the foreign subsidiaries will also boost profitability. These factors drive our above consensus expectations of an EPS CAGR of 41% between FY With improved free cash flows and a consequent fall in debt, balance sheet concerns (that were a key drag) should ease. Initiate coverage with a BUY rating and a TP of Rs415. Operating leverage benefits, capacity utilization to improve. BHFC s operating and financial leverage remains high we estimate that a 100bps improvement in utilization levels could lead to PAT rising by ~4 5%. The impact of BHFC s measures to improve productivity is also likely to be more visible once utilization levels improve we expect them to rise from 44% in FY13 to 54% in FY16 as: US/UK bottoming out and likely to recover: Data points (including lead indicators and GDP growth rates) suggest that the US and Europe are bottoming out. In the past two quarters, orders in the USA for class 8 type trucks are up sharply an indication of a potential demand pickup next year. New products, new customers driving growth: BHFC has been aggressively expanding its product and customer base while its automobile segment has focused on deepening relationships with existing clients, its non auto business is looking at enhancing its product and customer base. Product mix significantly improving: We expect three changes in BHFC s product portfolio over FY14 16 (a), an increase in the proportion of high margin machined products, particularly within the non automotive business, (b), higher share of exports as US/Europe recover faster than the Indian market in FY15, and (c), an increased share from the new facilities which manufactures complex and larger forgings. The full benefit of INR depreciation is also yet to flow through to the bottom line. Subsidiary consolidation is a positive: In the past year, BHFC has sold its stake in two loss making subsidiaries Bharat Forge America and FAW Bharat Forge China. These stake sales showcase the management s intent to consolidate its subsidiaries. We now expect the subsidiaries to add Rs2.3 to BHFC FY15 EPS (compared to a loss of Rs 2.9 in FY13). Above consensus earnings; FCF generation is a positive. With no major capex and an improvement in the business environment, we see a reduction in debt (D/E of 0.3x by FY16); consequently, balance sheet concerns should ease. We expect FY13 16 EPS CAGR at 41%, which is 10% above consensus. Valuations are reasonable, initiate with a BUY. BHFC currently trades ~15% below its average earnings multiple. However, given that (a), the current cycle (at least in export markets) has likely bottomed implying earnings could be consistently upgraded over the next few quarters, and (b), an expected easing of balance sheet concern (improvement in the D/E ratios), we believe the lower valuations are not justified. Initiate with a BUY and a target price of Rs415/share. BUY BHFC IN CMP RS 339 TARGET RS 415 (+22%) Company Data O/S SHARES (MN) : 233 MARKET CAP (RSBN) : 79 MARKET CAP (USDBN) : WK HI/LO (RS) : 353 / 186 LIQUIDITY 3M (USDMN) : 2.5 FACE VALUE (RS) : 2 Share Holding Pattern, % PROMOTERS : 46.7 FII / NRI : 13.8 FI / MF : 17.5 NON PROMOTER CORP. HOLDINGS : 7.6 PUBLIC & OTHERS : 14.3 Price Performance, % 1mth 3mth 1yr ABS REL TO BSE Price Vs. Sensex (Rebased values) Apr 10 Apr 11 Apr 12 Apr 13 Bharat Forge BSE Sensex Source: Bloomberg, Phillip Capital Research Other Key Ratios Rs mn FY14E FY15E FY16E Net Sales 59,170 59,525 66,163 EBITDA 10,228 11,528 13,069 Net Profit 4,204 5,357 6,440 EPS, Rs PER, X EV/EBIDTA, x EV/Net Sales, x ROE, % Debt/Equity, % Source: PhillipCapital India Research Est. Deepak Jain ( ) djain@phillipcapital.in Priya Ranjan ( ) pranjan@phillipcapital.in Please refer to Disclosures and Disclaimers at the end of the Research Report.

2 Table of Contents Focus Charts... 3 Investment summary... 4 Operating leverage benefits utilization to improve... 7 Product mix improving Subsidiary consolidation signals focus on bottomline Balance sheet to strengthen Earnings strong growth expected Valuations Risks Appendix Company Profile Financials of 34

3 Focus Charts Capacity utilization set to rise 65% Capacity Utilisation (%) 60% 55% 50% 45% 35% 30% 25% FY10 FY11 FY12 FY13 FY14E FY15E FY16E EBITDA margins to show a sharp improvement Debt equity to decline Debt to equity (x) FY10 FY11 FY12 FY13 FY14E FY15E FY16E Share of higher realization new non auto business rising 14,000 EBITDA EBITDA Margin (%) 25% 70% New Non Auto/Non Auto New Non Auto/Revenues 12,000 10,000 60% 50% 8,000 15% 6,000 10% 30% 4,000 2,000 5% 10% FY11 FY12 FY13 FY14E FY15E FY16E 0% 0% Q110 Q310 Q111 Q311 Q112 Q312 Q113 Q313 Q114 EPS contribution from subsidiaries to rise 4.0 EPS contribution from subsidiaries FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E Trading below historical levels P/E band 25x 600 (Rs) Apr 07 Apr 08 Apr 09 Apr 10 Apr 11 Apr 12 Apr 13 Apr 14 20x 15x 10x 3 of 34

4 Investment summary Despite an elongated downturn, Bharat Forge, one of the world s largest forgings companies, has been able to maintain its profitability levels. Benefits of the productivity boosting measures that BHFC has taken in the past will kick in as developed economies emerge out of the downturn. Its high operating and financial leverage has the potential to lead to an earnings surprise. Easing balance sheet concerns coupled with a consolidation of subsidiaries adds to our comfort. Our above consensus earnings expectations of an EPS CAGR of 41% between FY13 16 reflect these factors. Initiate coverage with a BUY rating and a TP of Rs415. A 1% improvement in the utilization levels can lead to a 4 5% higher PAT Utilization levels likely to improve leverage benefits to kick in Forging remains a capital intensive industry with low asset turnover ratios. BHFC s financial leverage also remains high, leading to a high operational leverage we estimate that a 1% improvement in the utilization levels can lead to a 4 5% higher PAT. Also, the company s cost cutting measures during the downturn could aid margin improvement. Over the FY13 16 period we expect BHFC s utilization levels to rise from 44% to 54% on an improvement in the global economy (USA and Europe in FY15); the Indian CV market could show growth only in FY16. Capacity utilization to rise going forward 65% Capacity Utilisation (%) 60% 55% 50% 45% 35% 30% 25% FY10 FY11 FY12 FY13 FY14E FY15E FY16E Note: Utilisation levels include non auto utilisations USA s orders for the class 8 type trucks could report a growth of 10% in CY14 US/UK bottoming out; India could deliver in FY16: Initial data from developed countries (including the composite leading indicators from OECD) seems to suggest a turnaround in the coming year USA s orders for the class 8 type trucks could report a growth of 10% in CY14. While Europe s heavy truck market could remain flat despite pre buying in CY13 on account of emission norms, however, the same norms (which require more complex forgings) imply that realization per tonne could rise. India replacement demand could drive growth in FY16. The Indian CV market remains in a downturn given the weak economic situation. While it is difficult to predict the exact timing of a recovery, we note that truck volumes in FY14 are very similar to sales in FY05. Given that the average life of a truck on the long distance route is ~10 years, it means that even replacement demand is not being met. This should lead to a sudden jump in demand once the economy improves. 4 of 34

5 Lead indicators signal a turnaround in the economy for USA/Europe BHFC gaining market share new products, new customers driving growth: BHFC has aggressively expanded its product and customer base; while its automobile segment has focused on deepening relationships with existing clients, its non auto business is looking at enhancing its product and customer base. Source: OECD, PhillipCapital India Research Share of high margin machined components has been rising over the past few quarters, particularly in the non automotive segment Product mix improving significantly BHFC s product mix is likely to improve in the coming quarters on three counts: (a), the share of high margin machined components (mainly in the non automotive segment) has been rising over the past few quarters; (b), share of exports in the standalone entity could rise from 51% currently to 55% in FY15 (with the recent INR devaluation, exports margins have risen sharply); and (c), BHFC s new facilities at Baramati are to cater to more complex forging products and as output from this unit rises, margins will improve. Share of machined components rising; new non automotive business gaining traction 60% 50% Machined component (% of sales) 70% 60% New Non Auto/Non Auto New Non Auto/Revenues 50% 30% 30% 10% 10% 0% FY07 FY08 FY09 FY10 FY11 FY12 FY13 0% Q110 Q310 Q111 Q311 Q112 Q312 Q113 Q313 Q114 Return ratios to rise on improved free cash flows leading to lower debt Focus on improving productivity at subsidiaries BHFC s management seems focused on improving the profitability of its subsidiaries even if it involves retracting the global footprint. The recent sale of two loss making subsidiaries (Bharat Forge America and FAW Bharat Forge China) is a clear step in that direction. Consequently, we expect subsidiaries to report EBITDA margins of ~7.2% in FY14 as against 5.2% in FY13 largely on operating leverage/cost cutting measures. 5 of 34

6 Balance sheet strengthening; earnings likely to surprise Balance sheet concerns that were a key drag on the stock are likely to recede. With improved free cash flows and a consequent improvement in debt levels, we expect return ratios to register a sharp improvement. Driven by a recovery in demand, benefit from the INR depreciation, an improved product mix and a reduction in interest costs, we expect BHFC s standalone earnings to report earnings CAGR of 22% between FY14 16 and consolidated EPS to grow by a CAGR of 24% this is 2% and 10% above consensus. Valuations are reasonable, initiate with a BUY. We value BHFC at Rs415, discounting our FY15 earnings by 18x. Our target multiple is slightly below the historical median multiple. We prefer a mid cycle valuation rather than assigning a recovery multiple, given that there are few signs of an improvement in the domestic market as of now. Nonetheless, earnings upgrades are possible over the next few quarters. Our target price implies an upside of around 22% from current levels. BUY. 1yr forward P/E chart valuations below mean Lots of scope for positive surprises earnings upgrades could happen over the next few quarters (Rs) P/E band 25x 20x 15x 10x Apr 07 Apr 08 Apr 09 Apr 10 Apr 11 Apr 12 Apr 13 Apr 14 6 of 34

7 Operating leverage benefits utilization to improve The inherent capital intensive nature of BHFC s business implies a high degree of leverage. The impact is magnified because of the company s high debt equity ratio. Consequently, we estimate that a 1% change in the utilization levels could lead to a 5% difference to the bottom line. Given that we expect utilization levels to rise from 44% to 54% over FY15 16, earnings could surprise on the upside. The full impact of cost cutting measures that the company has undertaken in the past few years is likely to be an additional trigger for margins to improve. Capacity utilization set to rise 65% Capacity Utilisation (%) 60% 55% After rising over FY10 12, utilization levels fell sharply and are currently below 50% 50% 45% 35% 30% 25% FY10 FY11 FY12 FY13 FY14E FY15E FY16E Note: Utilisation levels include non auto utilisations Our optimism on growth comes from two factors: (a), a clear improvement in the US and Europe, which will lead to an improvement in both the standalone business and subsidiaries, and (b), BHFC is looking at entering new product segments in both the automotive and non automotive segments. Manufacturing expenses have fallen sharply despite lower tonnage Impact of cost cutting measures visible It is clear that Bharat Forge has been taking a number of steps to improve its cost efficiency while improving productivity. In the last few quarters, it has not just managed to keep its employee costs in check, but has also substantially curtailed manufacturing expenses. It is noteworthy that manufacturing expenses in Q1 and Q2 have declined to ~17% of net sales this is the lowest level since Q4FY11 when shipped tonnage was ~ higher. While cost cutting has led to margins sustaining at high levels, it is likely to aid margin growth once demand recovers. 7 of 34

8 Manufacturing costs as a percentage of sales declining despite lower tonnage 21% Shipment tonnage('000 tonnes) (rhs) Manufacturing expenses (% of net sales) Shipment tonnage('000 tonnes) (rhs) Manufacturing costs/tonne 60 19% 18% 17% 16% % Dec 10 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 Jun 13 `Sep 13 Jun 12 Sep 12 Dec 12 Mar 13 Jun 13 `Sep 13 USA/ Europe on a turnaround, India could grow in FY16 There is a widespread expectation of USA s and Europe s economies turning the corner in CY14. In fact, indicators such as the consolidated lead indicators from OECD, seems to indicate that while the developed world is likely to turn the corner shortly, the developing world might be headed in the other direction. USA/Europe clearly showing signs of a recovery; GDP growth likely to be positive Advanced Economies United States Euro Area E 2015E Source: OECD, IMF 8 of 34

9 There is a strong link between GDP growth and CV sales Source: IMF, World Bank, IMC Automotive As we see in the following graphs, the CV production/demand is closely linked to the revival in the economies. In fact, data suggests that the correlation is clearly stronger for the OECD countries than for developing countries. The US is likely to lead BHFC s overseas market revival USA orders rising, volumes of class 8 trucks to rise by 10% There are clear signs that the USA class 8 truck market that drives demand for BHFC is showing signs of a revival the orders received in the past few months have shown a sharp uptrend. This should translate in higher volumes in Q1CY14. The ACT expects volumes of class 8 trucks to rise by 10% in CY14E. The average fleet age of the USA class 8 truck market has risen substantially in the last few years, indicating that replacement demand should also be strong once the economy recovers. Demand will likewise benefit from a certain degree of pre buying as emission norms change in FY16. USA Class 8 trucks to show growth Orders have been rising in the past two quarters US Class 8 trucks volumes ('000) E 2014E Class 8 truck orders Y o Y Growth (%) Jan 12 Feb 12 Mar 12 Apr 12 May 12 Jun 12 Jul 12 Aug 12 Sep 12 Oct 12 Nov 12 Dec 12 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep 13 Oct 13 Nov 13 Dec 13 60% 50% 30% 10% 0% 10% 30% 50% Source: ACT, PhillipCapital India Research 9 of 34

10 USA: Rising average fleet age of trucks: an opportunity for replacement demand 7.5 Avg fleet age US class 8 active population Source: ACT, PhillipCapital India Research In Europe, pre buying has been much more muted; therefore, loss of volumes in CY14 may not be as much Europe positive despite pre buying impact While the economic environment in Europe is likely to improve, the overall effect may be diminished by the 2013 pre buying on a change in emission norms. However, the impact of pre buying has been much more muted compared to previous emission norm rollovers. Hence, the loss of volumes in CY14 may not be as much and with the economy likely to improve, European volumes could show a sharp uptick in CY15. Initial forecasts from industry sources seem to suggest that CY14 truck volumes could be flat despite the pre buying effect in Additionally, the shift to new emission norms will require a modification of existing products this could help improve BHFC s realizations and profitability. The global luxury car market outlook continues to remain extremely strong and within cars, BHFC primarily supplies to the luxury segment. An improvement in the European economy augurs well for BHFC s non automotive business. India: replacement cycle could play out in FY16 Indian M&HCV volumes for FY14 are likely to hit the troughs of FY09. In fact, we estimate heavy truck volumes could be the lowest in a decade. India: Truck volumes indicate replacements being deferred In India, the probability of a recovery in truck volumes in FY16 is very high M&HCV replacement demand Replacement demand (% of sales) RHS FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E 1 100% 80% 60% 0% Source: SIAM, PhillipCapital India Research 10 of 34

11 The useful life of a truck on the national highway is estimated to be around 10 years (after which these trucks are typically relegated to intra state routes). Since volumes in FY15 are likely to be lower than the sales in FY05, we infer that even the truck replacement demand has been deferred. Therefore, truck volumes could show an upward trend even if the economy reports a moderate recovery. We believe that the probability of a recovery in FY16 (if not FY15) is very high. Non automotive segment will eventually be 60% of total revenues New products and customers driving growth Over the past few years, BHFC has clearly been looking to diversify its revenue stream one manifestation is the rising share of its non automotive business (up from of revenues in FY08 to ~ currently) and another is its foray into the capital goods space (with JVs with Alstom and MoUs with NTPC). The company is simultaneously attempting to increase its wallet share within the automobile space and seems to have recently gained domestic market share. Share of the new non automobile business has been rising 70% 60% 50% 30% New Non Auto/Non Auto New Non Auto/Revenues New non automobile segments have higher realizations Rs '000 New Non Auto Average Realisations) Total Average realisation 10% 0% Q110 Q310 Q111 Q311 Q112 Q312 Q113 Q313 Q Q110 Q310 Q111 Q311 Q112 Q312 Q113 Q313 Q114 Railways offer huge growth potential in the non auto segment Non automotive segment continuously ramping up This segment contributed of revenues in FY13 from of total revenues in FY08. BHFC expects the non automotive segment to eventually contribute to 60% of total revenues. The company plans to enter new segments and add new products to its existing product spaces. New areas being explored We estimate that over 2/3 rd of its non automotive business comes from just two segments oil and gas and construction and mining. This implies that a large number of segments notably railways, power and aerospace offer huge growth potential and are areas the company is likely to focus on. 11 of 34

12 BHFCs Segments present across a number of segments Automotive segment Non automotive Industry/segments CV and Passenger vehicles Oil and Gas Products Power train component (crankshaft, connecting rods), chassis component (front axles, steering knuckles), transmission parts Valves, drill bits, surface flow and sub sea equipment, machined crankshaft for pumps Construction and mining Machined crankshaft, tracklink and front spindle for construction products Power Rotor, forged blades turbine, shaft, crane wheel, rings transmissions Marine Crankshafts, connecting rods and propeller shafts. Locomotive Wheel sets, crankshafts axles, connecting rods, claw lock and piston Aerospace Wheel lever forging, fan forging, main leg forging Within new target segments, railways will be a key focus area In a recent interview, the management indicated that it expects to enter 5 6 new areas in the coming years, of which railways is a key one. BHFC has developed a new crankshaft for the Indian Railways (that was previously imported); it has already received initial orders from the railways and expects the business to grow to ~USD 100mn, or ~60% of the company s FY13 non automobile business. The company has also indicated that it could look at partnerships to manufacture diesel and electrical locomotive engines. It eventually aims at becoming one of the top three railway component suppliers globally. Railways outlay rising 1,200 Railway Capex (Rs bn) 1, FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E FY17E Source: Ministry of Railways, Planning Commission, Phillip Capital Research Long term outlook on some segments seems positive The outlook on some existing segments seems to be promising. For instance, in the oil and gas space, capex from global majors is likely to rise in the coming years despite concerns on their cash flows. This should drive the shift towards lower cost, high quality manufacturers implying gains for BHFC. An improvement in the construction market in the US could also revive demand. 12 of 34

13 Survey indicates ~70% of correspondents expect oil and gas capex to rise in CY O&G capex (capex outlook survey of company professionals) IncreaseDecrease IncreaseDecrease IncreaseDecrease IncreaseDecrease Upstream Oilfield Integrated Others Source: Oil and Gas Journal Automotive business deepening relationships Even in the cyclical nature of the automotive business, BHFC has been trying to gain market share. In fact, the downturn has facilitated the deepening of relationships, particularly in the domestic market. The downturn put pressure on small vendors, making BHFC an attractive alternate for OEMs Domestic market share seems to be rising Over the last two quarters, the CV market has shown a substantial dip of ~25%. However, BHFC s revenue decline has been much lower at just about 9% (refer table below), indicating that it has actually gained market share. This is mainly because the prolonged downturn put stress on the financial health of many vendors supplying smaller forging parts, making BHFC, with its strong financials and scale, an attractive alternative for OEMs. If the downturn continues, it could help BHFC consolidate its position further and the benefits will be visible when the industry rebounds. In addition, BHFC has received orders for products based on completely new platforms. The rollout of these trucks has increased BHFC s market share. Further, the company has made conscious efforts to enter new segments such as paasenger this could make an impact in FY16. BHFCs seems to be gaining share in the domestic market BHFC s domestic auto sales has declined less than M&HCV s 30% 10% BHFC Domestic revenue growth (%) M&HCV Volume growth (%) 30% 25% 0% 10% 15% 10% 5% 30% Sep 11 Mar 12 Sep 12 Mar 13 Sep 13 0% M&HCV Volume Decline BHFC Domestic Auto Revenue Decline 13 of 34

14 Supplying new products overseas BHFC has been trying to raise the scope of its product offerings in Europe by providing aluminum based products to higher end luxury cars and the management has indicated that newer automobile products are also on the cards. Alstom JV could add value over the medium term Bharat Forge and Alstom entered into a JV in 2011 to manufacture turbines. Their arrangement involves setting up of two JV companies one for manufacturing of steam turbines and generators and the other for manufacturing of all the auxiliaries. While the steam turbine JV began work on a plant in 2012 at Mundra, Gujarat, to manufacture MW turbines with an annual capacity of 5,000MW, the plans were delayed due to environmental clearances. BHFC s steam turbine JV with Alstom could begin production from 2015 it already has an order backlog of Rs 45bn It has shifted the plant to another location (Sanand) within Gujarat. Construction has already started and production is likely to begin by The JV has an order backlog of ~Rs45bn this includes an order from NTPC for three 660MW supercritical turbines. With Alstom s strong technological backing, once the plant is operational, new orders should flow in. Alstom Bharat Forge JV: Timeline FY10 Established JV with Alstom with plant to be established in Mundra FY13 Mundra (Gujarat) plant construction stopped due to environmental issues FY13 Received orders for two supercritical 660MW turbine from NTPC worth Rs15.7bn FY14 JV decided to shift the plant to Sanand, Gujarat FY14 Received orders for three supercritical 660MW turbine from NTPC worth Rs22.5bn FY15 Plant is likely to commence production by February 2015 India s power capacity to increase We do not build in any benefits from the Alstom JV 25,000 20,000 Power capacity addition (MW) 15,000 10,000 5,000 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E Source: Planning Commission, Phillip Capital Research 14 of 34

15 Product mix improving We expect three changes in BHFC s product portfolio over FY14 16 (a), an increase in the proportion of machined products particularly within the non automotive business, (b), higher share of exports as the US and European economies recover faster than the Indian market at least in FY15, and (c), an increased share of the non automotive business. These three trends point to an improvement in profitability. The higher margin earning machined components business should contribute to 55% of overall sales in FY16 from 50% in FY13 Higher proportion of machined components The proportion of machined components in BHFC s total sales has consistently improved in the past few quarters to ~54% currently from (~43% two years ago); most of the growth for this has come in the non auto segment in which the share of machined components has increased from an estimated 10% in Q1FY12 to ~35% Q1FY14. We believe that this trend is likely to continue in the coming quarters as BHFC increases the depth of its offerings in this relatively new segment. Machined components are typically value added products ensuring higher realizations and margins. We expect the overall share of machined components to increase from 50% of sales in FY13 to ~55% in FY16. Share of machined components to increase Machined tools as a part of non automotive space is rising 60% Machined component (% of sales) Machining (Non Auto share) 50% 35% 30% 25% 30% 15% 10% 10% 5% 0% FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E 0% Q1FY12 Q1FY13 1QFY14 15 of 34

16 Exports to rise at a faster pace in FY15 We expect BHFC s export volumes to report a stronger recovery than domestic volumes, largely because we see a global recovery led by USA and Europe while the domestic market could remain subdued even in FY15. We expect export share to rise from 51% in FY13 to 56% in FY15. In FY15, the share of exports in total revenues should rise The management has indicated that BHFC has been able to retain most of the INR depreciation benefits. In the coming quarters, average realizations should improve on higher depreciation (Q2FY14 rupee realizations were at Rs59/USD vs. the current rates of around Rs62/USD). Exports as a % of revenues to rise in FY15 Higher USD/INR realizations will aid margin growth 60% Exports (% of revenue) 70 Rupee realisation 50% % % 20 0% 10 `Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 Jun 13 Sep 13 Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Contribution from the new facilities at Baramati to rise In FY11, BHFC commissioned new facilities at Baramati capable of handling heavy/complex forgings, primarily for its non automotive business. Production from the facilities has shown a sharp uptick in the past few quarters (now contributing ~35% of the non automotive businesses from ~10% in Q1FY12). These new forgings with a higher degree of complexity offer better margins. The new non auto business has higher realizations Facilities at Baramati Facilities Product and Industries Product Dimensions Heavy Forge Division II 4,000 MT press and machining capacity Wind turbine components. Hydro, gas and steam turbine components and components for mining, metal industry and general engineering applications Max ingot weight up to 70T single piece. Centre for advanced manufacturing 80 MT Hammer and machining capacity Ring Rolling facility Large components for energy sector, transportation including aerospace, railways and marine Large rings & gears blanks for various sectors like marine, wind and construction equipment Source: Company Presentation, Phillip Capital Research Components up to 2.5 tonnes in weight and 4.5 m in length. Rings up to 3 tonnes in weight and 4.5m in diameter 16 of 34

17 Share of the new non automobile business has been rising 70% 60% 50% 30% New Non Auto/Non Auto New Non Auto/Revenues New non automobile segments have higher realizations Rs '000 New Non Auto Average Realisations) Total Average realisation 10% 0% Q110 Q310 Q111 Q311 Q112 Q312 Q113 Q313 Q Q110 Q310 Q111 Q311 Q112 Q312 Q113 Q313 Q of 34

18 Subsidiary consolidation signals focus on bottomline With the sale of its subsidiaries Bharat Forge America and its Chinese JV BHFC has completed a full circle. From expanding its global manufacturing footprint, it is now focused on improving its free cash flows and the bottomline of its overseas subsidiaries. We expect subsidiaries to report EBITDA margins of ~7% by FY15 vs. ~5% currently, largely on operating leverage and cost cutting measures. European subsidiaries have turned around Productivity improvements driving European subsidiaries profitability In the past few years, Bharat Forge has consolidated its subsidiary operations within Europe. On the one hand it has shut down plants (in Scotland) and on the other, it has rationalized its manpower. These moves seem to indicate a greater degree of flexibility, which has considerably lowered the breakeven point of its operations. With high operating leverage, an improvement in the topline in the past few quarters has raised the profitability of the European operations. We expect the European operations to report an EBITDA margin of 7% and a PAT CAGR of 36% in FY European Operations Likely to post growth Rs mn FY13 FY14E FY15E FY16E CDP GmbH Revenue 11,002 12,522 13,961 14,540 Growth (%) 7% 14% 11% 4% EBITDA ,136 1,198 EBITDA Margin (%) 5.3% 7.4% 8.1% 8.2% Aluminium Technik Revenue 2,646 3,106 3,544 3,758 Growth (%) 32% 17% 14% 6% EBITDA EBITDA Margin (%) 6.9% 7.2% 8.2% 8.8% Kilsta Revenue 6,791 7,878 8,351 8,852 Growth (%) 0% 16% 6% 6% EBITDA EBITDA Margin (%) 4.2% 4.8% 5.2% 5.3% Sale of Chinese subsidiary reduces debt and adds to the consolidated bottomline Sale of Chinese subsidiary will add to the bottomline BHFC had a 51% stake in a joint venture with FAW. While the strategic intent was compelling (to address the Chinese market with a strong local partner), FAW was losing market share and the CV market was not showing any signs of improvement therefore, BHFC exited the JV. The stake sale has two positive impacts (a), it reduces the consolidated debt by ~Rs5bn (or ~18%) and (b), it adds ~Rs2 per share to the consolidated EPS. Basic financials of the Chinese subsidiary Rs mn FY11 FY12 FY13 FY14 Revenue 6,113 6,253 5,580 5,022 EBIT (363) 75 PAT (643) (233) 18 of 34

19 Subsidiaries to be EPS accretive With the sale of two loss making entities, subsidiaries should now contribute meaningfully towards BHFC s bottom line. We expect the subsidiaries to now add Rs1.4 Rs2.9 in FY14 16 to the EPS compared with an average reduction of Rs1.5 in FY Contribution of subsidiaries to EPS to be positive in FY15/ EPS contribution from subsidiaries FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E 19 of 34

20 Balance sheet to strengthen FCF to improve; debt reduction on the cards Balance sheet concerns that were a key drag on the stock are likely to recede. With improved free cash flows and a consequent improvement in debt levels, we expect return ratios to register a sharp improvement. Free cash flow to be positive Unlike previous downturns (such as 2008), BHFC has been able to remain FCF positive (albeit marginally). With capacity utilization levels remaining low, it also seems like its investment phase is over. Capex is likely to remain low in the range of Rs2bn in FY15/16 compared with ~Rs6bn in FY10 12 and coupled with better operating cash flows, it will lead to a growth in FCF in FY15/16. FCF and FCF/Equity to show a sharp improvement (Consolidated) (Standalone) 8,000 Free cash flow (Rs mn) 8,000 Free cash flow (Rs mn) 6,000 6,000 4,000 4,000 2,000 2,000 (2,000) (2,000) (4,000) FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E (4,000) FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E Capex per annum to stabilize (Consolidated) (Standalone) 12,000 Capex (Rs mn) 6,000 Capex (Rs mn) 10,000 5,000 8,000 4,000 6,000 3,000 4,000 2,000 2,000 1,000 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E 20 of 34

21 Balance sheet deleveraging: Debt and D/E to decline Debt to decline We expect debt to decline due to higher free cash flows and the sale of its China JV. BHFC has realized Rs 1.75bn (6% of debt) from the sale of its share in the China JV and its share of the JV debt of ~Rs3bn should further bring down the total debt levels in FY14/15. We see debt declining from Rs28bn to Rs20bn by FY16, with consolidated D/E declining to a comfortable 0.3x by FY16. 20,000 Net debt (Rs mn) 1.20 Debt to equity (x) 18, ,000 14, ,000 10, ,000 6, ,000 2, FY10 FY11 FY12 FY13 FY14E FY15E FY16E FY10 FY11 FY12 FY13 FY14E FY15E FY16E Return ratios improving as capital efficiency rises Capital efficiency to improve In a capital intensive industry, one of the key concerns for BHFC has been its low capital efficiency. Its asset turnover ratio has been extremely low (at ~1.2x for the standalone business). However, we expect this ratio to improve to ~2.4x in FY16, based on improved utilization levels and higher realizations. Asset turnover ratios (Standalone) likely to improve 3.0 Fixed Asset Turnover ratio FY10 FY11 FY12 FY13 FY14E FY15E FY16E With a simultaneous improvement in profitability, return ratios are likely to show a sharp uptick in the coming quarters. 21 of 34

22 Return ratios to show an improvement Standalone Consolidated 25.0 ROE (%) ROCE (%) 25.0 ROE (%) ROCE (%) FY10 FY11 FY12 FY13 FY14E FY15E FY16E 0.0 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E 22 of 34

23 Earnings strong growth expected Driven by a recovery in demand, benefit from the INR depreciation, an improved product mix, and a reduction in interest costs, we expect BHFC s standalone earnings to report a CAGR of 22% between FY Consolidated earnings will benefit from the sale of its loss making JV in China and productivity improvements in European subsidiaries. Consolidated EPS to grow by a CAGR of 24% between FY Revenue growth to be high on higher tonnage Consolidated revenues affected by China stake sale; to grow by 6% We expect consolidated revenues to grow by 6% between FY14 16 and standalone revenues to report a growth of 13%. Consolidated revenue will be impacted by the sale of the Chinese JV, which had a turnover of Rs6bn in FY13 (~10% of net revenues). Excluding the Chinese JV revenues, we estimate consolidated revenues to be up by 11%. We expect standalone business utilization to improve from ~44% to 54%, driven by strong volume growth in the US and Europe in FY15 and a recovery in the Indian markets in FY16. We expect standalone tonnage to grow at a CAGR of 7% with realizations rising by 4%. Revenues growth excluding the sale of China to be strong Consolidated Standalone 80,000 Revenue (Rs mn) % Growth (rhs) 60% 50,000 Revenue Growth (%) (rhs) 70% 70,000 60,000 50,000 40,000 30,000 20,000 10,000 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E 50% 30% 10% 0% 10% 30% 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 FY10 FY11 FY12 FY13 FY14E FY15E FY16E 60% 50% 30% 10% 0% 10% Utilization levels to steadily rise 65% 60% 55% 50% 45% 35% 30% 25% Capacity Utilisation (%) FY10 FY11 FY12 FY13 FY14E FY15E FY16E. Note: Utilisation levels include non auto utilisations 23 of 34

24 EBITDA margins to improve We expect EBITDA margins to rise on: (a), operating leverage improvement on better utilization levels, (b), favorable currency movements, (c), sale of the low margin business in China, and (d), an improved product mix (higher share of machined products). Overall, we see EBITDA margins rising from 13% to an improvement of 640bps over the FY13 16 period. Average INR FY10 14 and current rate 70 INR/USD rate EBITDA margins could surprise positively FY10 FY11 FY12 FY13 YTD FY14 Current Source: Bloomberg, PhillipCapital India Research EBITDA margins (Standalone) (Consolidated) 28.0% EBITDA margin (%) 25.0% EBITDA Margin (%) 27.0% 26.0% 20.0% 25.0% 15.0% 24.0% 23.0% 10.0% 22.0% 5.0% 21.0% 20.0% FY10 FY11 FY12 FY13 FY14E FY15E FY16E 0.0% FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E Our earnings estimates are ~10% above consensus Financial leverage adds to bottom line earnings above consensus In addition to the operational performance, we expect BHFC to benefit from its substantial financial leverage and debt reduction. We see interest costs coming down by a CAGR of 10% from Rs1.9bn to Rs1.4bn. Depreciation levels are likely to show only a minor increase as the company s capex cycle has peaked. With improved operating performance, interest and depreciation costs as a percentage of EBITDA should decline from 50% to earnings should rise by a CAGR of 24% between FY of 34

25 Earnings and earnings growth to be strong (Consolidated) (Standalone) 7,000 PAT (Rs mn) % Growth 1 7,000 PAT (Rs mn) % Growth 160% 6,000 5,000 4, % 80% 60% 6,000 5,000 4, % 80% 60% 3,000 2,000 1,000 0% 3,000 2,000 1,000 0% 0 FY12 FY13 FY14E FY15E FY16E 60% FY10 FY11 FY12 FY13 FY14E FY15E FY16E 60% Leverage play: Depreciation +Interest/ EBITDA to decline 0.80 (Interest + Dep)/EBITDA FY12 FY13 FY14E FY15E FY16E Our earnings estimate are ~10% above consensus as we believe the market has not yet factored in the likely operating leverage and revenue upside from the potential recovery in the US and in Europe. PC Versus consensus EPS (Rs) EBITDA (Rs mn) Sales (Rs mn) FY14E FY15E FY16E FY14E FY15E FY15E FY14E FY15E FY16E Consolidated PC ,228 11,528 13,069 59,896 60,353 67,093 Consensus ,730 11,173 12,499 61,951 67,922 76,456 Diff (%) 14% 10% 12% 5% 3% 5% 3% 11% 12% Standalone PC ,613 9,801 11,134 34,002 37,616 43,373 Consensus ,260 9,526 10,564 32,633 37,606 42,344 Diff (%) 4% 3% 3% 4% 3% 5% 4% 0% 2% Source: Bloomberg, PhillipCapital India Research 25 of 34

26 Abridged P&L Consolidated (Rs mn) FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E Net Revenues 46,523 47,751 33,276 50,870 62,791 57,022 59,896 60,353 67,093 % change 3% 30% 53% 23% 9% 5% 1% 1,1% Operating expenses 39,478 43,211 29,936 43,017 52,826 49,328 49,668 48,825 54,024 Operating Profit 7,045 4,540 3,340 7,852 9,964 7,694 10,228 11,528 13,069 OPM (%) 15% 10% 10% 15% 16% 13% 17% 19% 19% % change 36% 26% 135% 27% 23% 33% 13% 13% Interest 1,269 1,291 1,303 1,534 1,860 1,908 1,835 1,464 1,362 Other income ,126 1,212 1,395 1,613 Depreciation 2,271 2,517 2,451 2,550 3,022 3,360 3,599 3,806 4,119 PBT 4,498 1, ,442 5,998 3,552 6,006 7,653 9,201 Tax 1, ,397 1,796 1,728 1,802 2,296 2,760 PAT Before Minorities/Associates 2, ,046 4,202 1,824 4,204 5,357 6,440 Minority/Associates/Discontinued operations /exc Pre exceptional PAT % change 69% 93% 4491% 35% 41% 69% 27% Abridged Balance Sheet Consolidated (Rs mn) FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E Share holders funds 16,541 16,435 14,642 19,529 21,839 22,564 25,409 29,134 33,399 Total loan funds 16,544 21,908 22,527 19,014 27,608 27,845 22,941 20,916 19,464 Total Liabilities 35,155 41,140 38,791 41,406 52,289 53,397 51,337 53,038 55,851 Net Fixed Assets 23,611 27,902 26,065 26,634 31,695 35,423 33,952 33,504 33,543 Investments 2, ,737 2,614 4,450 4,160 4,660 5,160 5,660 Inventories 7,271 7,916 6,575 8,115 10,961 11,320 11,557 11,370 12,603 Sundry debtors 6,718 5,313 5,044 7,539 8,134 6,114 6,421 6,460 7,180 Cash & Bank Balances 3,183 4,883 5,977 3,964 6,337 5,553 2,893 4,674 5,353 Others 7,609 7,203 6,576 7,883 11,765 11,824 12,417 12,492 13,885 Total current assets 24,781 25,316 24,171 27,501 37,197 34,812 33,288 34,995 39,020 Sundry Creditors 8,910 6, ,787 9,754 8,277 8,450 8,313 9,215 Acceptances 2,364 1, ,922 2,034 1,235 1,260 1,240 1,374 Other ,540 3,411 6,690 9,353 8,067 8,052 8,097 Provisions : 4,865 3,543 3,018 2,222 2,575 2,133 2,785 3,016 3,686 Total current liabilities 16,226 12,081 14,182 15,342 21,053 20,998 20,563 20,621 22,372 Net current assets 8,556 13,236 9,989 12,159 16,144 13,814 12,725 14,374 16,649 Total Assets 35,155 41,140 38,791 41,406 52,289 53,397 51,337 53,038 55,851 Abridged Cash Flow Consolidated (Rs mn) FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E Op. Profit before Working Capital Changes 7,587 5,446 2,705 8,064 10,882 9,154 11,068 12,514 14,232 Total Working Capital Changes 1,916 2,123 3,210 4,090 2, , ,596 Other 1, ,710 1,193 1,802 2,296 2,760 Net cash flow from operating activities (A) 4,284 2,612 5,422 3,407 6,864 7,576 7,695 10,351 9,876 Purchase of Fixed Assets including CWIP 7,599 5,472 1,426 5,089 9,821 5,605 2,129 3,358 4,158 Investments in subsidiaries Others 221 3,373 2, , Net cash used in investing activities (B) 7,383 2,095 4,161 4,004 10,498 2,102 2,257 3,449 4,208 Proceeds from long term borrowing 2,217 3,746 3,967 4,105 6, ,904 1,825 1,452 Proceeds from/(repayments of) short term Borrowings 1, , , , Dividend Paid , ,359 1,631 2,175 Others 1,336 1,113 1,787 2,397 1,769 2,111 1,835 1,464 1,362 Net cash used in financing activities (C ) 3,106 1, ,416 4,619 3,513 8,099 5,120 4,990 Net increase / (decrease) in cash and cash equivalents 6,206 1,700 1,093 2, ,960 2,661 1, Cash and cash equivalents at the beginning of the year 9,389 3,183 4,883 5,977 1,197 2,345 4,093 1,432 3,213 Cash and Cash Equivalents at End of the year 3,183 4,883 5,977 3,964 2,182 4,305 1,432 3,213 3, of 34

27 Abridged P&L Standalone (Rs mn) FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E Net Revenues 21,965 20,586 18,564 29,470 36,860 31,512 34,002 37,616 43,373 % change 6% 10% 59% 25% 15% 8% 11% 15% Operating expenses 16,743 16,988 14,408 22,315 27,707 24,357 25,389 27,814 32,238 Operating Profit 5,222 3,598 4,156 7,155 9,153 7,156 8,613 9,801 11,134 OPM 24% 17% 22% 24% 25% 23% 25% 26% 26% % change 31% 16% 72% 28% 22% 14% 14% Interest 1,050 1,004 1,028 1,214 1,505 1,534 1,510 1,332 1,285 Other income ,003 1,120 1,265 Depreciation 1,389 1,494 1,644 1,933 2,149 2,239 2,400 2,485 2,625 PBT 3,666 1,577 1,807 4,474 6,175 4,299 5,705 7,105 8,490 Tax 1, ,365 1,850 1,349 1,826 2,273 2,717 Pre exceptional PAT 2,432 1,033 1,270 3,108 4,325 2,950 3,879 4,831 5,773 % change 57% 15% 148% 38% 30% 33% 25% 19% Abridged Balance Sheet Standalone (Rs mn) FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E Share holders funds 14,733 14,869 15,284 19,954 21,431 23,111 25,631 28,831 32,429 Deferred Tax Liability 1,182 1,617 1,065 1,556 1,272 1,364 1,364 1,364 1,364 Secured loans 4,615 8,706 9,221 11,058 11,526 9,759 8,971 7,846 7,894 Unsecured loans 8,260 9,372 9,306 3,676 8,284 8,978 6,810 6,810 6,810 Total loan funds 12,875 18,079 18,528 14,734 19,810 18,737 15,782 14,657 14,705 Total Liabilities 28,790 34,565 34,877 36,244 42,512 43,213 42,777 44,852 48,498 Net Fixed Assets 17,450 20,634 19,146 18,417 20,850 22,216 21,331 20,374 19,277 Investments 5,937 3,672 7,209 8,144 9,362 9,306 11,306 13,306 15,306 Inventories 3,381 3,642 3,948 4,684 5,031 4,757 5,082 5,521 6,416 Sundry debtors 3,563 2,601 3,072 4,313 4,912 4,742 5,120 5,683 6,569 Cash & Bank Balances 1,650 3,667 4,935 2,320 5,006 2,791 1, ,855 Others 7,666 7,272 6,161 6,762 8,121 7,614 8,126 8,891 10,092 Total current assets 16,260 17,183 18,116 18,080 23,070 19,905 19,387 20,712 24,931 Sundry Creditors 3,894 2,253 3,644 4,242 4,622 3,307 3,532 3,454 4,014 Acceptances 2,364 1,415 1,888 1,922 2,034 1,235 1,319 1,433 1,665 Other , ,411 2,425 2,397 2,313 2,344 Provisions : 4,513 3,011 2,563 1,488 1,702 1,248 2,000 2,341 2,994 Total current liabilities 10,857 6,925 9,595 8,397 10,769 8,214 9,247 9,541 11,017 Net current assets 5,403 10,258 8,521 9,683 12,300 11,690 10,140 11,172 13,914 Total Assets 28,790 34,565 34,877 36,244 42,512 43,213 42,777 44,852 48,498 Abridged Cash Flow Standalone (Rs mn) FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E Op. Profit before Working Capital Changes 5,605 4,001 4,143 7,387 9,212 7,564 9,295 10,546 11,949 Total Working Capital Changes 1,174 2,037 1,603 3, , Others 985, ,708 1,129 1,826 2,273 2,717 Net cash flow from operating activities (A) 3,446 1,541 5,331 3,410 6,715 4,232 7,801 7,563 8,929 Purchase of Fixed Assets including CWIP 5,408 3,381 1,243 2,025 4,249 2,381 1,515 1,528 1,528 Investments in subsidiaries , ,000 2,000 2,000 Others 259 3,411 2, ,002 3, Net cash used in investing activities (B) 6, ,391 3,491 7, ,707 3,918 4,279 Proceeds from long term borrowing 1,467 3,555 3,143 3,787 4,032 1,354 3,257 1, Proceeds from/(repayments of) short term Borrowings , Dividend Paid , ,359 1,631 2,175 Others 1, ,095 1,545 1,292 1,556 1,510 1,332 1,285 Net cash used in financing activities (C ) 2,971 1, ,533 1,578 4,281 5,825 4,088 3,412 Net increase / (decrease) in cash and cash equivalents 5,713 2,017 1,268 2, , ,238 Cash and cash equivalents at the beginning of the year 7,363 1,650 3,667 4, ,060 2,791 1, Cash and Cash Equivalents at End of the year 1,650 3,667 4,935 2,320 1,060 1,341 1, , of 34

28 Valuations BHFC trades at a~15% discount to historical averages We value BHFC at Rs415, which discounts our FY15 earnings by 18x. Our target multiple is slightly below the median multiple of the last eight years, implying an upside of ~22% from current levels. BUY. Currently trades at a discount BHFC currently trades at a ~15x FY15 earnings a ~15% discount to its historical valuations. In our view, the earnings multiple fails to account for potential earnings growth. Assigning a median multiple not yet building in a recovery BHFCs trading multiple has varied between 13 25x in the last eight years, with a median of ~19x. The multiple varies in the stage of the cycle the highest multiple is during a recovery phase. While we are expecting recovery in the domestic market in FY16, we are not yet awarding BHFC with a corresponding multiple only when we see definite signs of a recovery would we would assign a higher multiple; therefore, further upsides are possible. One year forward P/E band (Rs) P/E band 25x 20x x x Apr 07 Apr 08 Apr 09 Apr 10 Apr 11 Apr 12 Apr 13 Apr 14 Valuations multiples (X) FY14E FY15E FY16E PER EV/EBITDA P/BV Source: PhillipCapital India Research 28 of 34

29 Risks A sustained macro economic slowdown is the key risk INR appreciation The sharp depreciation of the INR has clearly benefitted BHFC s margins, even if costs also rise to an extent because of it. However, overall, INR depreciation is beneficial to BHFC and is likely to have contributed ~250bps to its EBITDA margins. Our estimates for FY15/16 bake in an INR/USD rate of 61. An appreciation in the INR will have a negative impact on our margins and earnings. Higher than expected capex / acquisitions Our thesis is predicated on the company generating free cashflows to reduce its debt burden. Incase, capex rises substantially or the company makes an acquisition, the debt levels may not decline this would put our estimates and recommendations at risk. However, we note that the company has excess capacity and utilization levels remains indicating that substantial capex is unlikely for the next 2 years. Further, it seems to be focused on consolidating its footprint/subsidiaries rather than expanding it. Unfavorable election results, delayed recovery in investments A hung parliament in the upcoming elections has the potential to further defer investments and potentially derail even a moderate recovery in the economy. M&HCV volumes are directly correlated to the economy and the investment cycle. This may put our FY15/16 assumptions of M&HCV volume growth of 3% /15% at risk. Also an extended political uncertainty could lead to various government orders, particularly, in the non auto business being stalled. This could impact our revenue estimates from the non automotive segment. Continued slowdown in USA/Europe Exports account for nearly 50% of BHFC s domestic revenues with USA/Europe accounting for the majority. Our revenue is based on an assumption of a recovery in these economies. A continued slowdown in these geographies would put our earnings at risk. 29 of 34