ICICIDirect: Initiating coverage - Bharat Gears (Buy: Rs 62, Target: Rs 82)

Bharat Gears (BHAGEA)

Price: Rs 62 Target Price: Rs 82
OUTPERFORMER

Bharat Gears Ltd (BGL), one of India’s largest gear manufacturers, is well
positioned to cash in on the strong volume growth in the tractor and
commercial vehicle (CV) segment. The company completely wiped out its
accumulated losses in FY06 and is firmly on the road to profitability. We
expect net profit to grow at a CAGR of 38.1% over FY06-08E, translating into
an EPS of Rs 9.1 for FY08E on the post-rights issue equity. We rate the
stock an OUTPERFORMER.

Buoyancy in demand to continue: BGL's main customers are original equipment
manufacturers (OEMs) in the tractor and CV segment. Tractors contribute
around 60% to its revenue, while over 35% comes from CVs. The volume growth
from these OEMs due to strong demand and capacity expansion would drive
demand growth for BGL. We expect production to rise at a CAGR of 22.5% over
FY06-08E, while net sales are expected to grow at a CAGR of 15.4% to Rs223.3
crore.

Debt restructuring to improve bottom line: The company repaid high-cost debt
amounting to Rs 3 crore in FY06. In July 2006, the company came out with an
Rs 7.2 crore rights issue. The proceeds will be used to redeem preference
shares and repay high cost debts. With the projected cash generation from
operations, the company should reduce high-cost debt further. We expect
debt-equity ratio to improve from 9.8 in FY05 to 1.6 in FY08E, easing
pressure on bottom line. We expect net profit to grow at a CAGR of 38.1%
over FY06-08E.

Technology support from foreign partner: BGL has a financial and technical
collaboration with ZF Friedrichshafen of Germany, the world’s largest maker
of drivelines and chassis for automobiles. Product innovation and design
capabilities are becoming increasingly important for auto ancillary
manufacturers and the association will help the company design new products
for its customers for their new vehicle launches.

Valuations: We believe there is limited downside for revenue growth as the
company’s fortunes are directly linked to the continuously improving
performance of its clients. Debt restructuring would help ease the pressure
on bottom line. We estimate EPS to grow at a CAGR of 19.4% over FY06-08E. At
the current price of Rs 62, the stock discounts its FY07E EPS of Rs 6 by
10.3x and FY08E EPS of Rs 9.1 by 6.8x. We value the stock at 9x its FY08E
EPS to arrive at a target price of Rs 82.

Download here