HDF_101414_8857

VISIT NOTE 14 OCT 2014

Ramkrishna Forgings NOT RATED

Ready for the big leap Ramkrishna Forgings (RKF) is in the midst of scaling up from a predominant domestic CV forgings supplier to a mid-sized forgings player with potential to manufacture complex heavy duty forged components. By the end of the current fiscal, RKF would have completed its massive ~Rs 6.8bn capex, which was undertaken during the down-cycle years of FY13/14. With this expansion, RKF’s production capacity would rise by more than 2x and peak revenue potential by 3x over FY14 base. While the execution risks involved in the ramp-up stage cannot be undermined, comfort can be drawn from the fact that RKF has secured a sizable long term contract from a reputed international company for supplying heavy forged components.

With an improvement in asset turns and increase in the mix of higher value add products, we expect RKF’s operating margins to expand by 550bps over FY14-17E. As a result of weak earnings cycle and high capex spends, RKF’s return ratios had contracted significantly over the past two years. With a meaningful ramp-up in RKF’s new capacities by FY17, we expect the company’s ROE to scale-up to 22%.

RKF’s stock price has seen a sharp run-up in the past 12 months and current valuation stand at 12.7x/7.1x on EV/EBITDA basis for FY15/FY16.

Building blocks in place for 3x revenue growth and multi-fold PAT growth over FY14-17E RKF has already commissioned few of its new press

lines, and the balance capacities would progressively come on-stream by 2HFY16. RFK expects these new lines to increase revenue generation potential by ~Rs 10bn at peak utilization levels. The exports order book has been beefed up by a USD 100 mn/year long term contract for supply of heavy duty forged components.

RKF would also benefit from the anticipated upturn in the domestic CV cycle.

RKF’s margin profile should also witness substantial improvement as capacity utilisation improves from ~60% in FY14 to ~80% in FY17E and product mix turns richer with higher mix of heavy forged components.

Valuation and Views RKF currently trades at FY15/FY16 EV/EBITDA of

12.7x/7.1x and 21.1x/9.7x on P/E basis. We believe RKF’s FY17 earnings and return ratios would meaningfully reflect the benefits from its sizable capex, and based on this, we see healthy upside potential from a medium term perspective.

FINANCIAL SUMMARY (STANDALONE) (Rs mn) FY13 FY14 FY15E FY16E FY17E Net Sales 4,039 4,295 6,484 10,916 13,831 EBIDTA 616 576 1,064 1,993 2,616 APAT 110 85 302 688 1,060 EPS (Rs.) 5.2 3.2 11.0 24.0 37.0 P/E (x) 44.4 71.6 21.1 9.7 6.3 EV/EBITDA 12.1 19.0 12.7 7.1 5.3 RoE (%) 5.0% 2.9% 8.8% 17.2% 22.1% Source : Company, HDFC sec Inst Research

INDUSTRY AUTOS

CMP (as on 13 Oct 2014) Rs 232

Target Price NA Nifty 7,884

Sensex 26,384

KEY STOCK DATA

Bloomberg RMKF IN

No. of Shares (mn) 27

MCap (Rs bn) / ($ mn) 6.4/104.3

6m avg traded value (Rs mn) 9

STOCK PERFORMANCE (%)

52 Week high / low Rs 267/56

3M 6M 12M

Absolute (%) 20.9 81.3 236.2

Relative (%) 15.5 64.7 207.7

SHAREHOLDING PATTERN (%)

Promoters 48.01

FIs & Local MFs 15.93

FIIs 22.01

Public & Others 14.05 Source : BSE

Navin Matta [email protected] +91-22-6171-7322

HDFC securities Institutional Research is also available on Bloomberg HSLB <GO> & Thomson Reuters

RAMKRISHNA FORGINGS : VISIT NOTE

Company background

Ramkrishna Forgings (RKF) commenced operations in 1981 as a supplier of forged components to the Railway sector. The company expanded operations in 1997 and started supplying forgings to Auto OEMs. The company went public in 2004 with the objective of raising funds for expanding its forging capacity (from 5500 tons to 12150 tons) and installing machining capacities as a forward integration strategy.

The company currently supplies forged engine, transmission and axle group components – Spur gears, Synchro rings, Shafts, Wheel hubs, Pinions, Clamps and Spindles. RKF also supplies machined products including Crown wheels and Ring gears. Post commissioning its new heavy press lines, RKF’s product portfolio would include heavy duty and complex forged

components like Front Axle Beams, Crankshafts, Knuckles and Connecting rods.

RKF’s customer base includes most major CV makers such as Tata Motors, Ashok Leyland and VE Commercial vehicles. It also supplies forged components to global Tier I suppliers including Meritor, HEMA, Sisamex etc.

Mr. Mahabir Prasad Jalan is the promoter and Chairman of the company. He is a Mechanical Engineer from BITS, Pilani and has over 30 years of experience in the forging industry. Mr. Naresh Jalan is the Managing Director of the company. He holds an MBA with a specialization in Marketing from Symbiosis, Pune and has 15 years of experience in the forging business.

RKF – Product and revenue mix

Production and utilisation trends Revenue mix

Source : Company, HDFC sec Inst Research Source : Company, HDFC sec Inst Research

0%

20%

40%

60%

80%

100%

-

10,000

20,000

30,000

40,000

50,000

60,000

FY09 FY10 FY11 FY12 FY13 FY14

Forging (tons) Ring rolling (tons)

Forging utilisation % (RHS) Ring Rolling utilisation % (RHS)

0%

20%

40%

60%

80%

100%

FY09 FY10 FY11 FY12 FY13 FY14

Auto Railways Mining Exports Others

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Drivers in place for multi-fold revenue growth Despite a sharp cyclical downturn in the domestic CV

industry, RKF took a bold decision to invest Rs 6.8bn (almost 3x FY13 net worth) towards acquiring heavy duty press lines. Once fully commissioned, RKF’s installed capacity would increase by more than 2x to 150,000 tons. With this expansion, RKF would emerge as a mid-sized forging player with a capability to manufacture complex forged components. RKF aims to expand its product range to manufacture Front Axle Beams, Crankshafts, Knuckles and Connecting rods.

At peak utilization of its existing and new facilities, RKF can potentially ramp-up its topline to ~ Rs 17bn (~4X of FY14 revenue).

Few of the new lines have already started commercial operations, and balance would come on stream in a staggered format by 2HFY16. RKF has secured a prestigious USD 100mn/year five-year contract from a global Tier 1 auto component company. Of the total order value, USD 25mn worth of orders are for existing

product lines and balance USD 75mn for products likely to be manufactured from its new lines.

RKF’s export revenue has seen 40% CAGR over FY09-14 from a small base. The company supplies forged components to marquee Tier I auto component players such as Meritor, HEMA (Turkey), Sisamex (Mexico) etc. RKF is already in talks with several potential customers and is confident of bagging new export orders.

RKF expects to see increased traction in the domestic business as along with the anticipated cyclical upturn in the domestic CV cycle, the company plans to leverage on its expanded product range to gain wallet share from the domestic CV OEM and component suppliers.

While RKF has built-up a sizable order book to fill up ~70% of its capacities, the company’s execution capabilities would be a key monitorable going ahead. Successful ramp-up would provide the much needed scale to generate sizable FCF during cyclical upturns, which in turn could be invested towards growth capex/deleveraging initiatives.

RKF: Ramp-up in forging capacities RKF’s Auto segment revenue shows high correlation

with domestic CV volumes

Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research

-40%

-20%

0%

20%

40%

60%

FY10 FY11 FY12 FY13 FY14

RKF Auto revenue (% YoY) MHCV volumes (% YoY)

70k

17k 18k

45k

150k

-

25,000

50,000

75,000

100,000

125,000

150,000

175,000

FY14 July'14 Mar'15 Sept'15 FY16

3150& 4500 tons

6300 tons

12500 tons

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FUNDING DETAILS FOR HEAVY PRESS LINES

Source Currency Limits (mn in LC)

Amount (Rs mn) Comments

EXIM Bank INR 1000 1,000 Cost of debt - 12% IFC USD 14 760 Cost of debt - Libor + 400bps DBS Bank USD 10 555 Cost of debt - Libor + 300bps LBBW EUR 18.3 1,485 Cost of debt - Libor + 125bps SBI INR 700 700 Cost of debt - 12% Debt 4,500 IFC 275 Equity shares @ Rs 128/share Wayzata Partners 494 Equity shares @ Rs 132.75/share Promoter group 680 Equity shares/warrants conversion @ Rs 130/150 share Internal accruals 601 Equity 2,050

Source: Company, HDFC sec Inst Research Note: conversion of USD/Euro debt into INR based on average exchange rates during FY13/FY14 only used for indicative INR debt RKF has tied-up the entire funding requirement for the

expansion. Long term debt accounts for 70% of project cost, while the balance is funded through equity.

The company has secured foreign currency debt at fairly competitive interest rates. Currency risk associated with foreign currency payables would be hedged through higher export revenues.

Product mix and operating leverage to boost operating performance RKF’s operating margins have been on a declining trend

since FY11. In FY14, operating margin was 240bps lower as compared to its preceding five-year average. Declining forging and machining capacity utilization led to a negative operating leverage effect on its margins.

We expect RKF’s product mix to improve as its new products would command ~300-400bps higher margins compared to its existing products. Further, RKF has secured its long term contract at a favorable exchange rate, which should also flow through to its margins.

With a ~3x jump in revenues over FY14-17E, we expect utilization to improve to 82% by FY17 on its expanded asset base, which provides significant headroom for operating leverage gains.

Higher margin machining segment also saw reduced utilization of 50% in FY14 from ~70% in FY12. Based on the ensuing product mix, RKF expects to fully utilize its machining capacities over the next 12-18 months.

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RKF: Forging production and capacity utilisation trend

Source: Company, HDFC sec Inst Research

Financial analysis We expect RKF to deliver topline CAGR of 48% over

FY14-17E, largely on the back of ramp-up in export orders and recovery in domestic CV segment. We expect export revenue mix to increase from 23% in FY14 to 68% in FY17E as the company ramps-up supplies for its long term contract and also bags new export orders for heavy duty forged products.

We expect a 550bps improvement in operating margin over FY14-17E on the back of – i) Operating leverage benefit through higher capacity utilization, ii) Increase in mix of higher margin heavy duty forged products and iii) Higher machining mix. With operating margin expansion along with financial leverage benefit, we expect 125% CAGR in earnings over FY14-17E.

Historically, RKF has operated with a fairly long working capital cycle, which has seen a further bump-up in FY13/FY14, with average cash conversions increasing from 115 days in FY10-12 to 150 days in FY13-14. As

per the company, higher export revenue mix has lengthened the inventory/receivable cycle. Company expects inventory days to decline from current levels on the back of lower finished goods stock. This could lead to marginal improvement in its working capital cycle.

Although RFK would complete its heavy press lines capex in FY15, an increase in working capital requirement is likely to result in negative FCF during FY15/FY16. With healthy cash profit generation in FY17, we expect FCF to turn positive in the respective year.

RKF’s net debt/equity is likely to peak out in FY15 at 1.9x, once its capex gets completed. Thereafter, with healthy increase in networth, gearing should settle at 1.3x in FY17E.

RFK’s return ratios deteriorated quite sharply over FY11-14 as capacity utilization declined, margins contracted and debt levels increased. We expect ROE/ROCE to improve from 2.9%/3.3% in FY14 to 22%/11% in FY17E with improvement in asset turns and margins.

RKF : Weak FCF with high capex/working capital intensity

(Rs in mn) FY12 FY13 FY14 FY15E FY16E FY17E OFC (pre working cap) 694 540 532 928 1,654 2,094

Chg in working cap 79 (562) 163 (602) (1,625) (936)

CFO 773 (22) 696 327 29 1,158

Capex (534) (1,117) (3,416) (2,501) (150) (250)

FCF 239 (1,139) (2,720) (2,174) (121) 908 Source: Company, HDFC sec Inst Research

40%

50%

60%

70%

80%

90%

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

FY12 FY13 FY14 FY15E FY16E FY17E

Tonnage Capacity utilisation (RHS)

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Strong revenue growth and margin expansion Gearing likely to peak in FY15E


High working capital intensity Return ratios to recover


12%

14%

16%

18%

20%

-

3,000

6,000

9,000

12,000

15,000


Revenue (Rs mn) OPM % - RHS

-

0.5

1.0

1.5

2.0

2.5

-

2,000

4,000

6,000

8,000


Net debt (Rs mn) Net debt/equity (x) - RHS

40

65

90

115

140

165


Working capital days Inventory days

Debtor days Creditor days

0%

5%

10%

15%

20%

25%


ROAE % ROACE %

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Valuations and View RKF currently trades at an EV/EBITDA of 12.7x/7.1x on

FY15/FY16E. While one year forward valuations are broadly in-line with past five-year average, we believe that RKF would need to prove its execution capabilities in the heavy duty forging product segments before the stock could get further re-rated from these levels.

Although we would not look to discount FY17 just yet, we take cognizance of the fact that FY17 earnings are likely to jump by 54% YoY as RKF’s new capacities reach meaningful utilization levels. We would therefore argue that decent stock returns potential exists from a medium term horizon.

RKF: One year forward EV/EBITDA band chart


Key risks RKF is attempting to scale-up its operations by entering

into heavy duty forgings. While the company has ensured it sources its equipment from reputed vendors (SMS Meer, Germany for supply of 12500 ton press), the complexity involved in manufacturing of higher tonnage new products does increase execution risks in the business.

RKF has significantly leveraged its balance sheet to fund the capex for the heavy press lines. Inability to scale-up the new capacities as per expectation would adversely impact its debt servicing ability.

Company management expects export revenue to act as a natural hedge against the existing foreign currency liabilities on its balance sheet. However, in the event that export revenue growth lags expectations, RKF would need to build hedges to mitigate currency risk.

COMPARATIVE VALUATIONS

Company Mcap (Rs mn)

2Yr EPS CAGR

EBITDA margin P/E EV/EBITDA ROE % FY15E FY16E FY15E FY16E FY15E FY16E FY15E FY16E

Bharat Forge 179,256 30% 18.5% 19.2% 28.3 21.3 14.3 11.5 22% 24% Amtek Auto* 39,985 42% 20.3% 20.5% 4.2 3.3 5.3 4.6 11% 12% Ramkrishna Forgings 6,373 172% 16.4% 18.3% 21.1 9.7 12.7 7.1 9% 17% Source: Company, HDFC sec Inst Research *September year ended

4.0

6.0

8.0

10.0

12.0

14.0

Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14

EV/EBITDA (x) Mean +1 SD -1 SD

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INCOME STATEMENT : STANDALONE As at March (Rs mn) FY13 FY14 FY15E FY16E FY17E Net Sales 4,039 4,295 6,484 10,916 13,831 Growth (%) -19% 6% 51% 68% 27% Material Expenses 2,085 2,277 3,307 5,534 6,985 Employee Expenses 281 292 417 668 835 Other Operating Expenses 1,057 1,151 1,696 2,721 3,395

EBIDTA 616 576 1,064 1,993 2,616

EBIDTA (%) 15.2% 13.4% 16.4% 18.3% 18.9% EBIDTA Growth (%) -24% -6% 85% 87% 31% Other Income 13 24 128 13 15 Depreciation 226 249 387 511 568 Interest 217 223 368 468 481 PBT 186 128 437 1,027 1,582 Tax 76 43 136 339 522 PAT 110 85 302 688 1,060 APAT 110 85 302 688 1,060 APAT Growth (%) -54.6% -23.3% 257.0% 128.1% 54.0% EPS 5.2 3.2 11.0 24.0 37.0 EPS Growth (%) -61% -38.0% 239.2% 118.5% 54.0%


BALANCE SHEET : STANDALONE As at March (Rs mn) FY13 FY14 FY15E FY16E FY17E SOURCES OF FUNDS Share Capital 211 261 275 287 287 Reserves 2,330 2,971 3,385 4,075 4,949 Total Shareholders Funds 2,541 3,232 3,659 4,362 5,236 Long Term Debt 1,583 3,893 5,643 5,643 5,243 Short Term Debt 1,015 1,148 1,648 2,048 2,048 Total Debt 2,598 5,041 7,291 7,691 7,291 Deferred Taxes 318 309 357 491 696 TOTAL SOURCES OF FUNDS 5,458 8,582 11,308 12,544 13,223 APPLICATION OF FUNDS Net Block 2,422 2,337 7,950 7,590 7,522 CWIP 998 4,249 750 750 500 Goodwill - - - - - Investments, LT Loans & Advances 134 233 242 251 261 Inventories 1,492 1,571 2,185 3,678 4,661 Debtors 803 1,150 1,741 2,931 3,714 Cash & Equivalents 30 143 153 125 186 ST Loans & Advances, Others 385 442 416 520 569 Total Current Assets 2,844 3,539 4,737 7,506 9,391 Creditors 535 1,022 1,510 2,542 3,221 Other Current Liabilities & Provns 271 521 619 759 969 Total Current Liabilities 806 1,543 2,129 3,301 4,189 Net Current Assets 2,038 1,996 2,607 4,204 5,201 Misc Expenses & Others - - - - - TOTAL APPLICATION OF FUNDS 5,458 8,582 11,308 12,544 13,223


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CASH FLOW : STANDALONE As at March (Rs mn) FY13 FY14 FY15E FY16E FY17E Reported PAT 110 85 302 688 1,060 Non-operating & EO items (13) (24) (128) (13) (15) PAT from Operations 97 61 174 675 1,045 Interest expenses 217 223 368 468 481 Depreciation 226 249 387 511 568 Working Capital Change (562) 163 (602) (1,625) (936) OPERATING CASH FLOW ( a ) (22) 696 327 29 1,158 Capex (1,117) (3,416) (2,501) (150) (250) Free cash flow (FCF) (1,139) (2,720) (2,174) (121) 908 Investments (59) (8) - - - INVESTING CASH FLOW ( b ) (1,176) (3,424) (2,501) (150) (250) Debt Issuance 817 2,443 2,250 400 (400) Interest expenses (217) (223) (368) (468) (481) Share capital Issuance 377 661 178 180 - Dividend (29) (31) (53) (121) (186) FINANCING CASH FLOW ( c ) 1,211 2,817 2,056 80 (862) NET CASH FLOW (a+b+c) 14 89 (118) (41) 46 Non-operating and EO items 13 24 128 13 15 Closing Cash & Equivalents 30 143 153 125 186


KEY RATIOS : STANDALONE FY13 FY14 FY15E FY16E FY17E PROFITABILITY (%) GPM 48.4% 47.0% 49.0% 49.3% 49.5% EBITDA Margin 15.2% 13.4% 16.4% 18.3% 18.9% APAT Margin 2.7% 2.0% 4.7% 6.3% 7.7% RoE 5.0% 2.9% 8.8% 17.2% 22.1% RoIC or Core RoCE 4.3% 2.6% 4.2% 8.0% 10.5% RoCE 5.1% 3.3% 5.6% 8.4% 10.7% EFFICIENCY Tax Rate (%) 40.7% 33.9% 31.0% 33.0% 33.0% Asset Turnover (x) 0.7 0.5 0.6 0.9 1.0 Inventory (days) 135 134 123 123 123 Debtors (days) 73 98 98 98 98 Payables (days) 48 87 85 85 85 Cash Conversion Cycle (days) 159 144 136 136 136 Debt/EBITDA (x) 4.2x 8.8x 6.9x 3.9x 2.8x Net D/E 1.0 1.5 1.9 1.7 1.3 Interest Coverage 1.9x 1.6x 2.2x 3.2x 4.3x PER SHARE DATA EPS (Rs/sh) 5.2 3.2 11.0 24.0 37.0 CEPS (Rs/sh) 15.9 12.8 25.1 41.8 56.8 DPS (Rs/sh) 1.2 1.0 1.6 3.6 5.5 BV (Rs/sh) 120 124 133 152 183 VALUATION P/E 44.4 71.6 21.1 9.7 6.3 P/BV 1.9 1.9 1.7 1.5 1.3 EV/EBITDA 12.1 19.0 12.7 7.1 5.3 OCF/EV (%) (0.3) 6.4 2.4 0.2 8.4 FCF/EV (%) (15.3) (24.8) (16.1) (0.8) 6.6 Dividend Yield (%) 0.5% 0.4% 0.7% 1.6% 2.4%


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