Export Softness And Heavy Capex Will Likely Pressure Long-Term Earnings Trajectory

Catalysts

About Happy Forgings

Happy Forgings manufactures high precision forged and machined components for commercial vehicles, farm equipment, passenger vehicles and industrial applications.

What are the underlying business or industry changes driving this perspective?

• Heavy dependence on cyclical commercial vehicle and tractor segments, at roughly half of the long term mix, leaves the company exposed to prolonged weakness in global CV and agri cycles, which would cap volume growth and constrain revenue compounding.
• Large ongoing CapEx of INR 650 crores into wind, heavy hammers and near net technologies is being executed in a backdrop of soft exports and tariff uncertainty. This creates a risk of underutilised assets that would dilute returns on capital and pressure net margins.
• Strategic push into export led industrial applications such as wind, mining and data center power comes as Europe and North America face demand softness and energy cost pressures. This raises the risk that expected export scale up is delayed and earnings growth undershoots current expectations.
• Expansion into high horsepower tractors and heavy axles for international OEMs coincides with sharp volume declines and only tentative recovery signals in overseas agri markets. This increases the chance that new programs fail to offset legacy demand erosion and keep overall revenue growth subdued.
• Plans for inorganic expansion in specialised forging and machining, funded from a strong balance sheet, add integration and execution risks at a time when margins are at peak levels. Any misstep on acquisition quality or ramp up could compress EBITDA margins and slow earnings growth.

Assumptions

This narrative explores a more pessimistic perspective on Happy Forgings compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Happy Forgings's revenue will grow by 17.4% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 18.9% today to 18.2% in 3 years time.
• The bearish analysts expect earnings to reach ₹4.2 billion (and earnings per share of ₹44.59) by about December 2028, up from ₹2.7 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as ₹5.4 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 28.9x on those 2028 earnings, down from 37.0x today. This future PE is greater than the current PE for the IN Machinery industry at 28.5x.
• The bearish analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 14.94%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The company is delivering industry leading profitability with gross margins around 60% and EBITDA margins near 30%, supported by a premium, high machining content product mix. If this is sustained, it could keep earnings structurally higher for longer and support a higher share price through resilient net margins and profit after tax.
• A strong balance sheet with a debt equity ratio below 0.1, cash liquidity of over INR 300 crores and nearly 100% operating cash flow conversion provides ample capacity to fund growth and withstand downturns. This lowers financial risk and could potentially support higher valuation multiples and more stable earnings.
• The INR 650 crores strategic CapEx program is already backed by around INR 350 crores of annualised new orders, largely in higher value non auto industrial applications such as wind, heavy tractors and mining. If this program is executed well, it could accelerate long term revenue growth and expand EBITDA and gross margins.
• Secular growth in domestic demand across commercial vehicles, farm equipment, passenger vehicles and industrial segments, combined with diversification into wind energy, data center power and heavy axles, could offset export cyclicality and lead to a return to mid to high teens compound annual revenue growth. This could support stronger long term earnings.
• Management is actively pursuing inorganic opportunities in specialised, higher machining content forging businesses and expanding relationships with leading global and domestic OEMs. If these efforts are successful, they could add new platforms, technologies and customer bases that enhance scale and improve long run revenue visibility and return on capital.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Happy Forgings is ₹852.0, which represents up to two standard deviations below the consensus price target of ₹1120.57. This valuation is based on what can be assumed as the expectations of Happy Forgings's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₹1300.0, and the most bearish reporting a price target of just ₹852.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be ₹23.2 billion, earnings will come to ₹4.2 billion, and it would be trading on a PE ratio of 28.9x, assuming you use a discount rate of 14.9%.
  
• Given the current share price of ₹1065.5, the analyst price target of ₹852.0 is 25.1% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.