The company’s negative outlook surprised analysts since they were building a case that a healthy order backlog for the heavy trucks segment in North America to support Bharat Forge’s earnings for FY20, and the impact of a contraction in order inflows for new trucks to reflect only in FY21. But, the recent inventory correction by the US truck makers show that the pain will be visible during the current fiscal.
Bharat Forge has been facing headwinds in its forging component segment meant for the trucks in the domestic and international markets, which accounts for two-thirds of the total standalone revenue. Revenue of the trucks export division dropped by 18% in the September quarter as truck makers reduced their inventory on the expectation of recession in the US market next year. Bharat Forge has guided for a lower production volume of the Class 8 truck — a gauge of the North American heavy truck market — at 345,000 units in 2019 compared with 325,000 in the previous year. For the next calendar year, the company expects 20% and around 8% decline in the US and European markets respectively.
The risk of lower Class 8 truck orders will increase if the US economy slows further. This will result in order cancellations, affecting the export volumes of Bharat Forge. The revenue for the export division is expected to grow marginally in the current fiscal and may decline by 20-25% for the next fiscal.
Back home, the Indian truck industry has been facing a downturn with monthly volumes hitting the lowest in a decade. The company’s revenue in the domestic division fell by 67% in the September quarter. It does not expect any major lift in volumes during the coming quarters owing to advance purchases ahead of new emission norms effective April 2020. The revenue from the domestic truck segment is likely to decline by 35% for the current fiscal.
With a downturn imminent in two significant business verticals, the company has shifted focus on cost reduction, improvement in productivity and cash flows. The operating margin before depreciation (EBITDA margin) fell by just over 60 basis points to 25.4% sequentially even though the volume drop was higher than the previous quarter.
Given the slowing demand, analysts may downgrade Bharat Forge’s estimated operating profit while the cut in earnings per share (EPS) will be less due to lower corporate tax.
Its stock underperformed the BSE Auto index by 10% in the past three months. The stock’s price-earnings (P/E) multiple is expected to shrink further. At Monday’s cosing price of ₹435.4, the stock was traded at 21 times FY21expected earnings compared with the five year average of 25.