Bharat Forge Rating: Reduce-German order jolts progress on ESG front

Bharat Forge’s (BHFC’s) German subsidiaries have been fined EUR32 mn by Germany’s competition regulator, Bundeskartellamt, due to cartelisation. The fine covers (a) aluminium and (b) steel forgings (yet to be settled) cartelisation case. Key findings (press release) were: (i) Five aluminium forging companies were engaged in cartelisation for ~12 years (starting Apr’06) and have been fined EUR 175 mn; (ii) collaborative behaviour was found for product price increases to customers; and (iii) companies passed on only value creation process benefits to customers and not procurement cost benefits.

We have earlier highlighted the sub-par performance of the international subsidiaries and raised concerns on the deterioration of profitability and sub-par RoCEs. This event raises more questions on the way forward and may cause concern for key stakeholders, customers and minority shareholders. Maintain Reduce.

Details from the order: Three German subsidiaries of Bharat Forge— Aluminiumtechnik GmbH, Bharat Forge CDP GmbH and Bharat Forge Global Holding GmbH—have been fined EUR32 mn on account of anti-competitive behaviour. Investigations found that from 2006 to 2018, senior executives of the companies met on 23 occasions with the purpose of exchanging cost factors information for passing on the cost increases to their customers. The companies were in general agreement that their respective procurement costs and cost increases would be passed on to their customers.

At their meetings, senior staff members regularly exchanged information on individual costs incurred in their procurement processes. They also agreed to calculate lifetime reductions only based on their own value creation process and not to apply such reductions to procurement costs as well.

Our view: We believe the action taken against Bharat Forge is likely to surprise its customers too, and can have either/or: (i) long-term relationship impact; (ii) cause product pricing renegotiations in near term. This could further delay efforts to turn around loss-making entities. These subsidiaries had weak financial performance in the past even with such pricing benefits. As minority investors get more focussed on ESG metrics, this event potentially raises concerns on business ethics, and could negatively impact its future ESG scores. We maintain our valuation multiple at 26x Dec’22e EPS and add Rs 42/share fair value (DCF basis) for defence business to arrive at an unchanged TP of Rs 482.