RamKrishna Forgings - Play the auto boom!

RamKrishna Forgings (CMP Rs 116.70) is a classic play on the Indian auto boom. The automobile industry is the key demand driver of forgings, accounting for about 65% of the total forging production worldwide. Other industries that consume forgings include the engineering industry, railways, Defense, chemical process, oil exploration, cement and steel. The aggressive growth plans at Tata Motors (Tata Motors is a leading customer of RamKrishna) should create demand for the company.

The forging industry is a capex driven with 60% of the cost being from the raw material component which includes items such as carbon, alloy, stainless steel, aluminum, titanium, brass, and copper. Any increase in raw material price would be detrimental to the company’s margins and the industry works as a converter of raw material rather then with any pricing power. Over the past three years the company has been able to significantly improve upon its financials and its return ratios. This indicates that it has been more then able to pass on the cots of rising inputs to its customers.

The Operating margins have expanded to 18.05% in 2006 from 8.52% in 2003 while The RoE has also jumped to 19.51% from 11.40% during the same period. Presently the company trades at a PE of 21 times to its FY 06 EPS.

The company derives a majority of its sales from Tata Motors. So this has an advantage and also a disadvantage. The advantage stems from Tata Motor’s aggressive expansion program and the disadvantage is that dependence of a single buyer would never ensure Ram Krishna get above market margins and also the market would  be a bit wary in giving it a higher PE.

Apart from this the company also supplies to various Govt. agencies like defense and railways  The company is also increasing the (ring rolling) capacity which should be on stream by January 2007.This facility should increase the total capacity to  51,000 tonnes  from 26,000 tonnes

The company expects to increase its top line by at least 70% once the new facility comes on stream.

Recommendation: RamKrishna forging appears almost fairly priced based on the past financials which does not indicate the company’s plans but once the new facility comes on stream the EPS could double. I would categorize this industry as a cyclical and therefore it needs to be watched with caution because when ever the cycle turns investors need to get off the train as fast as they can. When that would turn is anybody’s guess.

Source: Company feedback and media reports

If Tata is the biggest customer and if institutional investors are interested, it might be due to the launch of ek laak ki gaddi. Huge volumes can really change the fortunes of small companies like this one.