Mid Cap IT SCOPE FOR ALPHA, BUT AT THE RIGHT PRICE
Date - 24 September 2020 Table of Contents
1 Mid cap IT reports healthy 1QFY21, initiate on Mindtree, Sonata 3-5
2 Top Picks & Valuation 7-8
3 Competitor Benchmarking 10-13
4 Company Section
Mindtree 15-24
Sonata Software 25-34
Persistent Systems 35-44
Tata Elxsi 45-54
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Mid cap IT reported healthy margins on cost control, further scope in select companies; ER&D under performs • COVID-19 pressurised revenue in 1QFY21… • Revenue for most mid-sized IT firms declined 1-18% QoQ in 1QFY21 in USD terms (only Persistent reported growth), as the pandemic impacted demand across verticals, with supply side issues of transitioning to a WFH model also impacting growth. • Clearly, ER&D firms were impacted more, with the 4 companies in our sample reporting 9-15% QoQ revenue declines; vertical- specific issues for some firms (Aerospace & Defence for Cyient, Automotive for KPIT) and ER&D investments being discretionary in nature contributed to the greater revenue decline of this segment compared with IT services. • Among IT services firms, Persistent, Birlasoft and Hexaware out-performed peers, with Persistent reporting 3.1% QoQ growth in revenue, while the latter 2 companies reported smaller 1-3% QoQ revenue declines; Sonata (-17.8% QoQ) and Mindtree (-9.1% QoQ) were the under-performers, mainly owing to Travel exposure, with ex-Travel revenue flattish-to-growing. • …but margin performance, cash flow impressed; ER&D under-performs again • Profitability was impressive for most mid cap IT firms, with margin expansion ranging between 110-390bps QoQ on cost control and favourable currency; Coforge (earlier NIIT Technologies) under-performed peers, with a 238bps QoQ margin decline. • ER&D firms under-performed across-the-board, recording 150-330bps QoQ margin decline. • Cash flow was a key theme in 1QFY21, given need to conserve cash, and have leeway to invest as and when demand returns; most IT firms reported healthy operating cash flow, with Mindtree’s cash from operations at nearly 200% of EBITDA. • Stocks surge post results, increasing criticality of technology, fast tracked digital investments drive increase • Post 1QFY21 results, most mid cap IT stocks have surged 40-100%, as expectations of swift growth recovery took centerstage even among under-performing companies. • Increasing criticality of technology, fast-tracked digital investments and company-specific factors have driven stock performance.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Initiate Coverage on Mindtree, Sonata with ACCUMULATE ratings; good long term business outlook • Positive outlook on mid caps covered in this report; company-specific factors drive our underlying confidence • We initiate coverage on 2 companies in this report – Mindtree and Sonata Software. We expect Mindtree to see improved growth from 2QFY21 with resumption in global economic activity, continuing digital investments by client organisations, healthy growth in non-Travel verticals, top client Microsoft and large deal wins like Realogy acting as bulwarks, and margin expansion over FY21- FY23 led by revenue growth and cost management. Recent strategy refresh with focused service offerings to end-decision makers of technology with higher digital focus, and cutting long tail of clients should boost growth as well in the long-term. Key risk is client concentration (>30% revenue accounted for by top client Microsoft in 1QFY21, which will get addressed over the next 2-3 quarters). Valuation is slightly pricey at 22.0x/19.2 FY22E/FY23E EPS, respectively. We are positive on long term business prospects of the IT firm, and recommend an ACCUMULATE rating with a target price of INR 1,420. We recommend buying into any stock price correction. • We believe the worst is now behind Sonata Software, with 1QFY21 being a trough quarter owing to the severe decline in Travel revenue led by TUI. Other key verticals including ISV, Retail (Essential and Non Essential), Distribution & Manufacturing, and Commodities & Services should see growth return. Sonata enjoys healthy operating metrics, with impressive IITS EBITDA margin of >22% (better than most mid-sized IT firms), gross debt-equity ratio at a very conservative 0.1x (net cash positive), interest coverage ratio of >22x in FY20, no equity dilution since April 2001, operating cash flow well in excess of 100% of EBITDA and RoE consistently above 30% since FY15. In context of improving growth, differentiated business model with platform focus, marquee acquisitions boosting cash usage and expanding addressable market, and healthy operating metrics, we Initiate Coverage on Sonata Software with an ACCUMULATE rating and target price of INR 375. The stock currently trades at 11.9x/10.7x FY22E/FY23E EPS, respectively, which is fairly reasonable.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Remain positive on long term businesses of Persistent and Tata Elxsi, prefer lower prices to add further
• We are enthused by the pivot made by Persistent under the earlier CEO towards managed services, annuity revenue, technology services business and large deals, driven by a realignment of service lines and verticals to effectively map client IT spend to its own portfolio of offerings. This has seen results in terms of improved revenue and margin performance over the past few quarters, no more so than in 1QFY21, a quarter when most peers reported mid single digit to double digit revenue declines. Deal wins have also been healthy, with Persistent winning a US$ 50mn deal with a leading enterprise software firm in the data virtualisation space, with growth visibility aided further by good traction in its digital banking products in the BFSI vertical, and initiatives in the Healthcare vertical. While near-term margin pressure could be seen owing to transition costs in large deals, this can be recouped with revenue growth. We expect 11.3% USD revenue CAGR over FY21-FY23E after a 9.6% growth in FY20, and , and 12.8% EPS CAGR over the period after 18.6% growth in FY20. We maintain ACCUMULATE on Persistent with an upwardly revised target price of INR 1,340, implying a target PE of 20x FY23E EPS. Persistent’s stock trades at 20.0x/18.3x FY22E/FY23E EPS, respectively at current levels. • Tata Elxsi’s stock currently trades at a P/E multiple of 23.0x/20.2x FY22E/FY23E EPS, respectively. Improving vertical mix diversification, near-term margin expansion, relevant service portfolio in fast-growing areas of IT spend such as embedded software, automotive electronics, AR/VR, OTT media and medical devices, and healthy double digit EPS growth (14% CAGR over FY21- FY23E) underpin our positive stance on the specialised IT firm. We value the stock at 22x FY23E EPS and arrive at a revised target price of INR 1,308 (INR 1,064 earlier) as we factor in FY23E earnings. We retain our ACCUMULATE rating on the stock and believe the recent 8% correction is a good opportunity for investors to add to their portfolio.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
1 Mid cap IT reports healthy 1QFY21, initiate on Mindtree, Sonata 3-5
2 Top Picks & Valuation 7-8
3 Competitor Benchmarking 10-13
4 Company Section
Mindtree 15-24
Sonata Software 25-34
Persistent Systems 35-44
Tata Elxsi 45-54
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Preferred picks: Accumulate on all, positive on long-term business outlook, Sonata attractive from valuation standpoint
Stock Recommendation CMP (INR)* Target Price (INR) Upside* (%)
Mindtree ACCUMULATE 1,294 1,420 9.7
Sonata Software ACCUMULATE 335 375 12.0
Persistent Systems ACCUMULATE 1,226 1,340 9.3
Tata Elxsi ACCUMULATE 1,199 1,308 9.1
Source: Company Reports, KRChoksey Research *As of 23 September 2020
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Tata Elxsi, Mindtree command premium valuations, Sonata awarded fair discount owing to size, Travel exposure
Market Recommendati P/E (x) EV/EBITDA (x) RoE (%) Stock capitalisation on (INR Mn) FY22E FY23E FY22E FY23E FY22E FY23E
Mindtree ACCUMULATE 213,722 22.0 19.2 13.6 11.8 25.2 25.9
Sonata ACCUMULATE 34,787 11.9 10.7 7.5 6.5 38.1 37.0 Software
Persistent ACCUMULATE 93,430 20.0 18.3 12.3 10.9 17.0 17.6 Systems
Tata Elxsi ACCUMULATE 75,028 23.0 20.2 14.8 12.7 23.5 23.2
Source: Company Reports, Bloomberg, KRChoksey Research *As of 23 September 2020
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
1 Mid cap IT reports healthy 1QFY21, initiate on Mindtree, Sonata 3-5
2 Top Picks & Valuation 7-8
3 Competitor Benchmarking 10-13
4 Company Section
Mindtree 15-24
Sonata Software 25-34
Persistent Systems 35-44
Tata Elxsi 45-54
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
1QFY21 USD revenue growth comparison – Persistent shows healthy out-performance
(%, QoQ)
5 3.1
0 -1.2 -5 -3.5 -6.8 -10 -9.1 -8.7
-15 -12.5 -12.5 -15.2 -20 -17.8 Mindtree Hexaware Persistent Coforge* Birlasoft Sonata** Cyient L&T Tech. Tata Elxsi$ KPIT Tech. 1QFY21 EBIT margin change – Sonata impresses despite severe revenue decline
(Bps chg, QoQ) 385 400
240 127 144 113 80
-80 -51 -240 -184 -148 -238 -400 -328 -309 Mindtree Hexaware Persistent Coforge Birlasoft Sonata** Cyient L&T Tech. Tata Elxsi KPIT Tech.
Source: Company Reports, Bloomberg, KRChoksey Research * In CC terms; ** For Sonata’s IITS business, with IITS EBITDA margin change shown: $ INR change
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
USD revenue growth comparison, trend
(%, QoQ)
15
8
1
-6
-13
-20 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 Mindtree Hexaware Persistent Coforge* Birlasoft** Sonata$ Cyient LTTS Tata Elxsi# KPIT**
EBIT margin trend
(%)
30
24
18
12
6
0 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 Mindtree Hexaware Persistent Coforge Birlasoft** Sonata** Cyient LTTS Tata Elxsi KPIT**
Source: Company Reports, Bloomberg, KRChoksey Research • In CC terms: ** Data post completion of the de-merger; $ For Sonata’s IITS business; # In INR terms
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Cash conversion – Healthy for all bar Persistent
Particulars (1QFY21, Rs mn) Cash From Operations (CFO) EBITDA CFO/EBITDA % Mindtree 6,348 3,220 197.1 Hexaware Technologies* 5,301 2,713 195.4 Persistent Systems 733 1,464 50.1 Birlasoft 1,613 1,129 142.9 Cyient 2,163 995 217.4 L&T Technology Services 3,406 2,059 165.4 USD revenue, growth comparison USD revenue (mn) 1QFY20 4QFY20 1QFY21 QoQ (%) YoY (%) Mindtree 264.2 278.4 253.2 -9.1 -4.2 Hexaware Technologies 188.5 210.6 208.1 -1.2 10.4 Persistent Systems 119.6 127.1 131.0 3.1 9.5 Coforge** 9,627.0 11,093.0 10,570.0 -4.7 9.8 Birlasoft 111.7 125.6 121.2 -3.5 8.5 Sonata Software 44.3 44.4 36.5 -17.8 -17.6 Cyient 156.6 149.2 130.6 -12.5 -16.6 L&T Technology Services 193.9 195.4 171.0 -12.5 -11.8 Tata Elxsi** 3,617.1 4,388.9 4,004.9 -8.7 10.7 KPIT Technologies 72.8 76.9 65.3 -15.2 -10.3
Source: Company Reports, KRChoksey Research *Hexaware has a December-ending FY. Thus, 1QFY21=2QCY20. ** In INR million.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Headcount trend Headcount (Nos.) 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 Mindtree 18,990 19,402 19,908 20,204 20,935 21,267 21,561 21,991 21,955 Hexaware Technologies 15,357 16,050 16,205 16,509 18,294 19,062 19,999 19,998 18,825 Persistent Systems 8,902 9,302 9,530 9,962 10,167 10,543 10,532 10,632 10,829 Coforge 9,764 10,025 10,144 10,263 10,297 10,800 10,849 11,156 10,598 Birlasoft* N.A. N.A. 9,953 10,061 10,085 9,994 10,129 10,268 9,908 Sonata Software 3,454 3,679 3,812 3,886 3,863 4,036 4,028 4,066 3,966 Cyient 14,411 14,385 14,532 14,424 14,398 14,215 13,854 13,251 12,182 L&T Technology Services 13,081 13,585 14,777 15,140 15,913 16,789 16,787 16,883 16,641 Tata Elxsi 5,397 5,932 6,061 6,060 5,981 5,947 6,389 6,577 6,618 KPIT Technologies* N.A. N.A. N.A. 6,614 6,891 7,295 7,303 7,125 6,806
Attrition trend Attrition (%) 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 Mindtree 12.2 13.0 13.4 14.2 15.1 16.5 17.2 17.4 16.6 Hexaware Technologies 14.4 15.7 17.0 18.2 18.2 17.3 15.8 15.1 14.0 Persistent Systems 14.8 15.4 16.4 16.7 17.1 15.7 14.9 14.3 12.7 Coforge 10.1 10.8 11.7 12.2 13.0 12.3 11.9 11.8 11.8 Birlasoft* N.A. N.A. 19.0 19.9 21.7 22.5 20.3 18.9 16.5 Sonata Software 17.5 17.0 17.0 17.4 17.6 16.2 15.5 16.9 13.3 Cyient 18.2 18.4 21.2 19.9 17.4 18.0 19.7 18.9 13.6 L&T Technology Services 15.4 15.0 14.9 14.8 15.8 13.4 13.9 13.8 11.4 Source: Company Reports, KRChoksey Research * Data available from 3QFY19/4QFY19 post demerger taking effect.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
1 Mid cap IT reports healthy 1QFY21, initiate on Mindtree, Sonata 3-6
2 Top Picks & Valuation 8-9
3 Competitor Benchmarking 11-14
4 Company Section
Mindtree 15-24
Sonata Software 25-34
Persistent Systems 35-44
Tata Elxsi 45-54
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
EBIT margin – Healthy expansion, potential for further improvement
(%) 15 13.7 12.0 12.5 12 9.3 9 6.4 6
3
0 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 Cash conversion – Robust in 1QFY21, reflects focus on tightening the ship in difficult times
(% of EBITDA) 197.1 200
160 150.2 128.1 120 89.1 80
40 22.2
0 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21
Source: Company Reports, KRChoksey Research
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Microsoft revenue trend – Top client, a runaway success story, to continue to drive growth
(%) (US$ mn) 6.3% CQGR 80 76.2 60 53.0 72 49.9 69.0 50 63.6 43.5 64 41.4 40 55.8 53.1 33.1 56 51.9 28.8 30 49.8 50.3 26.4 46.9 48 20 13.3 40 12.2 10 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 Microsoft revenue YoY growth (RHS)
CMT vertical – Robust growth driver, led by top client Microsoft
(US$ mn) (%) 4.1% CQGR 135 129.2 30
125 25.7 26.0 119.7 26 23.6 114.0 24.1 115 22 21.0 107.8 103.8 104.1 105 18 96.7 99.0 93.8 15.1 15.3 95 14 11.4 85 10.9 10 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21
CMT revenue YoY growth (RHS)
Source: Company Reports, KRChoksey Research
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Revenue/client – Rising trend (apart from 1QFY21) reflects better focus on fewer clients
(Nos.) (US$ mn) 349 350 346 343 4.0 339 341 340 336 3.7 320 3.6 322 3.4 3.4 3.3 307 3.1 308 3.0 3.0 3.1 2.9 3.0 292 294 2.9 2.8 280 2.5 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 Active client base Annualised average revenue/client (RHS)
Revenue growth - Healthy double digit growth likely, led by strategy refresh, CMT and CPG verticals
(US$ mn) (%)
1,350 1,301.4 15 1,280 11.3 11.7 11 8.7 1,210 1,165.0 7 1,140 3 1,088.8 1,070 1,046.8 -1 -3.9 1,000 -5 FY20 FY21E FY22E FY23E Revenue Revenue growth (RHS)
Source: Company Reports, KRChoksey Research
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
EBIT, margin forecasts – Improving trend likely, aided by revenue growth
(INR mn) (%) 14,432 15,000 15 14.8 14.4 13,500 13.8 12,547 14 12,000 13 10,860 10,500 12
9,000 8,061 11 10.4 7,500 10 FY20 FY21E FY22E FY23E EBIT EBIT margin (RHS)
EPS forecasts – Healthy growth, aided by revenue improvement and margin expansion
(INR) (%)
70 67.5 36 33.3 62 58.8 24
54 51.1 15.1 14.8 12
46 0 38.3 38 -12 -16.3 30 -24 FY20 FY21E FY22E FY23E EPS EPS growth (RHS)
Source: Company Reports, KRChoksey Research
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
CMP Target Potential Upside Market Cap (INR Mn) Recommendation Sector INR 1,294 INR 1,420 9.7% INR 213,722 ACCUMULATE Information Technology
About the company • Mindtree is a mid-sized Indian IT services firm that offers a wide range of IT services to clients ranging from application development, automation, business process management, infrastructure management, ER&D services, IT consulting, cloud ,data analytics, IoT, digital marketing and user experience services. Its major verticals of focus include Communications, Media & Technology, CPG, Retail & Manufacturing, Travel & Hospitality and BFSI. Mindtree earns a lion’s share of its revenue from the US (79% in 1QFY21), followed by Europe (13.3%), India (4.1%) and Rest of the World (3.8%). The company employed nearly 22,000 people as of 1QFY21-end. Mindtree has grown revenue, EBIT and PAT at CAGRs of 16.9%, 5.8% and 3.3%, respectively over the period FY15-FY20.
MARKET DATA KEY FINANCIALS
Shares outs (Mn) 164 Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E Equity Cap (INR Mn) 1,646.74 Revenue (USD Mn) 1,001 1,089 1,047 1,165 1,301 Revenue 70,215 77,643 78,606 87,373 97,607 Mkt Cap (INR Mn) 213,722 EBIT 9,004 8,061 10,860 12,547 14,432 52 Wk H/L (INR) 1255.70/671.90 FDEPS (INR) 45.8 38.3 51.1 58.8 67.5 Volume Avg (3m K) 1219.85 EBIT margin (%) 12.8 10.4 13.8 14.4 14.8 Face Value (INR) 10 PE ratio (x) 28.2 33.8 25.3 22.0 19.2 Bloomberg Code MTCL IN EV/EBIT (x) 23.8 26.4 19.3 16.4 14.0 Source: Company, KRChoksey Research Investment Rationale SHARE PRICE PERFORMANCE Margins, cash flow enthuse in 1QFY21, revenue recovery likely from 2Q led by CMT, CPG verticals 300 Mindtree reported better-than-expected profitability in 1QFY21, with EBIT margin up 127bps QoQ due to slashing of major costs including travel and subcontractor; this is the 4th successive quarter of sequential margin expansion, with margin up 475bps since 1QFY20 on an adjusted basis and up 735bps on a reported basis. Cash from operating activities 200 was robust at 197% of EBITDA, aided by higher profitability and impressive working capital management. We expect the IT firm to return to revenue growth in 2QFY21, led by the CMT and CPG verticals. On profitability, Mindtree is looking to further expand margin from 1QFY21 levels, aided by revenue growth apart from levers like higher offshore. We factor in 11-12% USD revenue growth in FY22E-FY23E after 4% decline in FY21, along with 40-50bps annual EBIT margin expansion, and expect 14.5-15% margins by FY23. 100 Microsoft remains the bulwark for fast-growing CMT vertical, large deals like Realogy to further boost growth
0 Microsoft revenue has clocked a robust CQGR of 6.3% over the past 8 quarters, implying annualised growth of 27.5%. We believe there is further legroom for growth in the top
account, given Microsoft’s own growth outlook in light of major investments on the hybrid cloud front. Mindtree is witnessing healthy revenue traction in CMT, aided by rapid
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- adoption of cloud, workplace modernisation, agile and automation technologies; large deal wins from existing clients like Realogy will address client concentration to some
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extent, and the non-Microsoft part of CMT will start contributing more meaningfully in subsequent quarters. Thus, we expect Mindtree to achieve 2.5% USD revenue CQGR till
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Mar 4QFY21, aided by CMT and CPG, and healthy 1QFY21 order book (renewals up 27% YoY); a healthy exit rate in 4QFY21 will provide a strong base for double digit FY22 growth. Mar Mindtree Sensex Strategy refresh to focus on realigning service offerings; cutting long tail to drive focus on larger clients Post the new CEO & MD, Debashis Chatterjee taking over in August 2019, Mindtree is shifting focus towards the end-buyer of services apart from merely the CIO in client organisations. The company is regrouping its service lines as well, in line with its focus on end-users of technology at the front end with greater digital component. Thus, Mindtree will essentially drive a focused ‘4x4x4’ strategy in terms of verticals, geographies and service lines. We believe this strategy refresh will enable the IT firm to P/E multiple chart effectively address client digital spend. Mindtree is also focusing on cutting the long tail of clients. We believe this strategy of improved focus will enable Mindtree to better 50 Valuation (TTM) allocate resources, focus on high-growth digital services, and to effectively mine existing large clients like Realogy, which will boost revenue growth. Valuation 29.6 23.5 Mindtree’s stock trades at a PE of 22.0x/19.2x FY22E/FY23E EPS. The IT firm seems well-placed to drive revenue growth from 2QY21 onward, led by the 17.4 CMT and CPG verticals. Accelerated digital investments owing to the COVID-19 pandemic are likely to play well into Mindtree’s service realignment. The
0 strategic refresh and larger client focus should also enable the IT firm to drive more predictable revenue growth. We expect Mindtree to record ̃11.5%
USD revenue CAGR over FY21E-FY23E. Even as we expect some elements of the cost structure to return from 2Q and 3QFY21 onward, we expect
improved revenue growth to boost EBIT margin by 40-50bps annually over FY21E-FY23E. Thus, we expect ̃15% EBIT and EPS CAGR over the period. While
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Mar/18 Mar/19 Mar/20 current valuation appears slightly on the higher side, we are positive on Mindtree’s long-term business prospects and would recommend buying the PE Average stock on declines. We Initiate Coverage on Mindtree with an ACCUMULATE rating and target price of INR 1,420, valuing the stock at 21x FY23E EPS.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 19 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Investment Rationale a) Margins, cash flow enthuse in 1QFY21, revenue recovery likely from 2Q led by CMT, CPG verticals • Mindtree has moved firmly into the “L&T age”, with the original promoters exiting the company and a new professional CEO & MD, Debashis Chatterjee (ex-Cognizant) joining in August 2019; the company has recorded improved performance after a challenging 1QFY20, the last quarter under the previous promoter ownership, with steady margin improvement. • The IT firm reported better-than-expected profitability in 1QFY21 (EBIT margin up 127bps QoQ due to slashing of major costs including: travel cost - down 61% QoQ and 210bps as a % of revenue, subcontractor cost - down 20% QoQ and 111bps as a % of revenue, and other expenses - down 24% QoQ and 173bps QoQ as a % of revenue) despite poor revenue performance (USD revenue down 9.1% QoQ, mainly owing to a 55% QoQ decline in the Travel vertical); this is the 4th successive quarter of sequential margin expansion, with margin up 475bps since 1QFY20 on an adjusted basis and up 735bps on a reported basis. • Cash flow was also robust, with cash from operating activities (CFO before income taxes) at 197% of EBITDA, against 128% in 1QFY20; in absolute terms, CFO rose nearly 170% YoY, aided by substantially higher profitability and impressive working capital management, with lower trade receivables and other current assets substantially improving the working capital profile. • We expect the IT firm to return to revenue growth in 2QFY21, led by the CMT and CPG verticals, aided by digital investments by client organisations in the form of cloud, workplace modernisation, agile and intelligent automation in these verticals. • Top client Microsoft and large deals like Realogy will further boost growth from 2QFY21, with the CMT vertical also likely to start witnessing growth in non-Microsoft clients, which will improve client concentration, currently high given that Microsoft contributed >30% to revenue in 1QFY21; this will revert to lower levels from 2Q onward, given that 1QFY21 was an exceptional quarter on account of the steep decline in the Travel vertical. • On profitability as well, Mindtree is looking to further expand margin from 1QFY21 levels, aided by revenue growth apart from levers like higher offshore. It should be noted that the IT firm will not shy away from making investments for growth, even as focus will be to ensure minimal margin volatility, which has been the case on numerous occasions in the past. • We factor in 11-12% annual USD revenue growth in FY22E-FY23E after a 4% decline in FY21, along with 40-50bps annual EBIT margin expansion on top of 343bps expansion in FY21, and expect 14.5-15% margins by FY23.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
• Mindtree is regrouping its service lines as well, in line with its focus on end-users of technology at the front end with greater digital component, and the IT firm will break out its service offerings into 4 key areas encompassing customer success, data insights, cloud and enterprise IT; all these have high digital component and there is good potential for cross-sell as well. Thus, Mindtree will essentially drive a focused ‘4x4x4’ strategy in terms of verticals (CMT, CPG, Retail & Manufacturing, Travel & Hospitality, and BFSI), geographies (US, Europe, India, and RoW) and service lines. • We believe this strategy refresh will enable the IT firm to effectively address client digital spend, which is likely to get accelerated post the COVID-19 pandemic, as clients look to rapidly move to new technologies to address ‘digital native’ market segments such as ‘Generation Z’, apart from the need to focus more on digital channels as physical interactions take time to return to pre-COVID levels (if at all). • Mindtree is also focusing on cutting the long tail of clients that give it low revenue, or where it sees lack of digital spend of IT vision from the client end and where employees are tied up in low yield accounts. The IT firm has seen its active client base shrink by 54 ( ̃16%) over the past 4 quarters since the new CEO & MD took over, as the IT firm looks at higher yield clients in line with its strategy of better focus. Revenue per client rose steadily at 5.3% CQGR from 1Q-4QFY20 before falling in 1QFY21 due to revenue decline. We believe this strategy of improved focus will enable Mindtree to better allocate resources, focus on high-growth digital services, and to effectively mine existing large clients like Realogy, which will boost revenue growth. Valuation – 2Q recovery, strategy refresh, large client focus to drive growth, Initiate Coverage with ACCUMULATE Mindtree’s stock trades at a PE of 22.0x/19.2x FY22E/FY23E EPS. After posting a decent 1QFY21 ex-Travel, along with margin expansion and cash flow, the IT firm seems well-placed to drive revenue growth from 2QY21 onward, led by the CMT and CPG verticals, with the key Microsoft account and Realogy deal to boost the former. Accelerated digital investments owing to COVID-19 are likely to play well into Mindtree’s service realignment, which focuses on leveraging digital investments in a more focused manner. The strategic refresh and larger client focus, with cutting the long tail a recurring effort, should also enable the IT firm to allocate resources more efficiently and drive more predictable revenue growth, along with keeping S&M costs under control. We expect Mindtree to record ̃11.5% USD revenue CAGR over FY21E-FY23E, after recording ̃4% USD revenue decline in FY21E. Even as we expect some elements of the cost structure to return from 2Q and 3QFY21 onward, we expect improved revenue growth to boost EBIT margin by 40-50bps annually over FY21E-FY23E, after a 343bps expansion in FY21E. Thus, we expect ̃15% EBIT and EPS CAGR over the period. While current valuation appears slightly on the higher side, we are positive on Mindtree’s long-term business prospects and would recommend buying the stock on declines. We Initiate Coverage on Mindtree with an ACCUMULATE rating and target price of INR 1,420, valuing the stock at 21x FY23E EPS.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Exhibit 1: Profit & Loss Statement Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E Revenue (USD mn) 1,001 1,089 1,047 1,165 1,301 Revenue 70,215 77,643 78,606 87,373 97,607 Employee cost 44,212 50,647 51,595 56,816 63,118 SG&A and other expenses 15,358 16,181 13,706 15,411 17,336 EBITDA 10,645 10,815 13,305 15,146 17,154 Depreciation & Amortisation 1,641 2,754 2,445 2,599 2,721 EBIT 9,004 8,061 10,860 12,547 14,432 Interest Cost 29 529 510 481 453 Other Income 893 756 808 758 838 PBT 9,868 8,288 11,158 12,823 14,817 Income tax 2,327 1,979 2,746 3,145 3,704 PAT before minority interest 7,541 6,309 8,412 9,678 11,113 Minority interest 0 0 0 0 0 PAT after minority interest 7,541 6,309 8,412 9,678 11,113 Diluted EPS (INR) 45.8 38.3 51.1 58.8 67.5
Exhibit 2: Cash Flow Statement Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E Net cash generated from Operations 6,233 7,912 8,560 10,578 11,811 Net cash flow from Investing Activities -1,933 -229 -1,572 -1,573 -1,562 Net cash flow from Financing Activities -5,221 -6,960 -3,951 -4,938 -6,913 Net inc/(dec) in cash equivalents -921 723 3,037 4,067 3,336 Opening balance 3,289 2,562 3,909 6,946 11,014 Other adjustments 194 624 0 0 0 Closing cash and cash equivalents 2,562 3,909 6,946 11,014 14,349
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Exhibit 3: Balance Sheet Exhibit 4: Ratio Analysis Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E Particulars FY19 FY20 FY21E FY22E FY23E Equity share capital 1,642 1,646 1,646 1,646 1,646 Reserves 31,419 29,922 34,383 39,123 43,323 Tax rate (%) 23.6 23.9 24.6 24.5 25.0 Net worth 33,061 31,568 36,029 40,769 44,969
Borrowings 5 - - - - RoE (%) Operating lease liability - 4,964 4,964 4,964 4,964 24.9 19.5 24.9 25.2 25.9
Other liabilities 174 1,798 1,798 1,798 1,798 RoCE (%) 22.8 19.0 24.2 24.7 25.2 2,131 2,587 2,477 2,685 2,931 Accounts payable Other current liabilities 5,020 8,925 8,737 9,590 10,602 Current ratio (x) 3.2 2.5 3.0 3.2 3.3 1,399 1,724 1,147 1,433 2,007 Provisions EBITDA margin (%) Total current liabilities 8,550 13,236 12,361 13,708 15,540 15.2 13.9 16.9 17.3 17.6 Total Liabilities 41,790 51,566 55,153 61,239 67,271 EBIT margin (%) 12.8 10.4 13.8 14.4 14.8 Gross block 11,773 12,081 13,653 15,226 16,788
8,016 8,681 11,126 13,725 16,446 Net profit margin (%) Depreciation 10.7 8.1 10.7 11.1 11.4
3,757 3,400 2,527 1,501 342 PE ratio (x) Net block 28.2 33.8 25.3 22.0 19.2 Capital work in progress 297 136 136 136 136 Goodwill and Intangible assets 5,912 5,491 5,491 5,491 5,491 EV/EBITDA (x) 20.1 19.7 15.8 13.6 11.8 Non current investments 1,200 804 804 804 804
Long term loand and advances 675 457 457 457 457 EV/EBIT (x) Deferred tax assets, net 388 1,835 1,835 1,835 1,835 23.8 26.4 19.3 16.4 14.0 Right of use assets - 5,201 5,201 5,201 5,201 Other non current assets 1,889 1,693 1,693 1,693 1,693 13,356 14,389 15,721 17,953 20,859 Accounts receivable Short term loans and advances 123 99 99 99 99 Current investments 6,836 6,944 6,944 6,944 6,944 2,562 3,909 6,946 11,014 14,349 Cash and bank 4,795 7,208 7,297 8,111 9,061 Other current assets 27,672 32,549 37,008 44,121 51,312 Total current assets Total Assets 41,790 51,566 55,153 61,239 67,271
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Travel vertical – Bottom hit in 1QFY21, likely to stabilise hereon
(US$ mn) (%) 15 20 11.3 11.2 2.3 12 11.1 -0.8 9.8 0 -13.0 -20 9 -40 6 -60 3 1.5 -80 -85.1 0 -100 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 Travel revenue QoQ growth (RHS)
Essential Retail vertical – Healthy growth even in 1QFY21
(US$ mn) (%)
2.5 30 26.5 2.2 2.2 23.3 24 1.9 1.8 18
1.6 1.4 12 1.3 1.4 1.3 6 2.3 3.3 1.0 0 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 Retail (Essential) revenue QoQ growth (RHS)
Source: Company Reports, KRChoksey Research
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Digital revenue trend (US$ mn) (%)
20 40.0 40 17.8 18 16.8 16.9 39 15.9 16 38.0 38.0 14.6 38 14 37.0 37
12 36.0 36
10 35 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 Digital revenue % of revenue (RHS) IP-led revenue – Impressive performance, key growth driver going forward
(US$ mn) (%)
12.5 35 11.9 12.0 11.7 32.6 32
11.5 11.3 29 11.0 11.0 26 10.5 25.1 25.4 23.8 24.2 10.5 23
10.0 20 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 IP-led revenue % of revenue (RHS)
Source: Company Reports, KRChoksey Research
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
IITS revenue – Healthy growth likely post challenging FY21, aided by non-Travel verticals, IP focus
(US$ mn) (%)
200 21 190.2 14 190 12.2 12.5 10.0 180.8 7 180 172.9 0 170 -7 160 153.7 -15.0 -14 150 -21 FY20 FY21E FY22E FY23E IITS Revenue Revenue growth (RHS)
IITS EBITDA, margin – Improvement likely, aided by revenue growth, cost optimisation (INR mn) (%)
3,500 25 3,138 3,200 24 2,853 2,900 2,794 23
2,600 22.0 2,420 22.0 22.0 22 2,300 21.0 21
2,000 20 FY20 FY21E FY22E FY23E IITS EBITDA IITS EBITDA margin (RHS)
Source: Company Reports, KRChoksey Research
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
EPS growth – Robust recovery likely post-FY21, aided by revenue growth and margin improvement
(INR) (%)
35 35 29.5 32 31.3 24
29 28.2 13 26.711 .1 10.9 26 2
23 21.8 -9
20 -18.3 -20 FY20 FY21E FY22E FY23E Cons. EPS EPS growth (RHS)
Source: Company Reports, KRChoksey Research
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
CMP Target Potential Upside Market Cap (INR Mn) Recommendation Sector INR 335 INR 375 12.0% INR 34,787 ACCUMULATE Information Technology About the company • Sonata Software is an Indian IT firm based out of Bangalore. The company has 2 businesses – Domestic Products and Services (DPS) and International IT services (IITS), with DPS accounting for ̃66% of FY20 consolidated revenue, while IITS accounted for 34%, while in terms of EBITDA, it was IITS that accounted for the lion’s share of ̃75% of total EBITDA, with DPS accounting for 25% of total EBITDA. In the DPS business, Sonata essentially distributes products of key principals including Microsoft, Oracle, Symantec and SAP. In the IITS business, Sonata provides a range of IT services to clients from the ISV, Retail & CPG, Travel, Manufacturing, Commodities and EPS industries, including application management, data and analytics, cloud transformation, digital assurance and Microsoft Dynamics. Sonata provides a range of industry-specific and horizontal platforms spanning ERP, MS Dynamics, travel, commodities, retail, e- commerce and mobility, which is a key differentiator. The company employed >4,100 people as of 1QFY21-end. Sonata has grown revenue, EBIT and PAT at CAGRs of 17.3%, 15.8% and 15.7%, respectively over the period FY15-FY20.
KEY FINANCIALS MARKET DATA Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E Shares outs (Mn) 105 IITS Revenue (USD Mn) 161.2 180.8 153.7 172.9 190.2 Equity Cap (INR Mn) 105.16 Mkt Cap (INR Mn) 34,787 Cons. Revenue 29,609 37,433 38,719 42,878 47,166 52 Wk H/L (INR) 354.40/148.10 Cons. EBIT 3,229 3,363 2,818 3,595 3,976 Volume Avg (3m K) 532.47 FDEPS (INR) 24.0 26.7 21.8 28.2 31.3 Face Value (INR) 1 EBIT margin (%) 10.9 9.0 7.3 8.4 8.4 Bloomberg Code SSOF IN PE ratio (x) 14.0 12.6 15.4 11.9 10.7 SHARE PRICE PERFORMANCE EV/EBIT (x) 10.3 9.2 10.8 8.4 7.3 Sonata Sensex 300 Investment Rationale 250 Worst appears to be behind after a difficult 1QFY21, Travel exposure down to just 4% of IITS revenue, key client TUI likely to see pick up 200 Sonata was one of the worst-hit IT firms in 1QFY21 due to COVID-19, recording a substantial 17.8% QoQ USD revenue decline, as its second-largest client – German travel major TUI Group – suspended operations and most of its IT spend. We expect the IT firm to report much-improved performances from 2QFY21 onward, as 150 economies have gradually opened up and TUI has resumed some of its operations. It should be noted that ex-Travel, Sonata’s revenue saw a 1.2% QoQ growth in 100 USD terms, aided by growth in Retail (Essential) and ‘Others’ (+23.3% and +25.5% QoQ). With return of some pent-up IT spend in non-Travel verticals, we expect Sonata’s differentiated vertical-agnostic platform strategy to drive return to growth from 2QFY21. 50 Platform, IP differentiator to drive growth
0
Software platforms – horizontal and vertical – are Sonata’s major focus areas to drive growth and profitability. Vertical-wise, Sonata provides a digital travel
17
19 19 18
18 platform to the Travel, Retail, Consumer Goods and Commodity industries, while horizontally, the company provides enterprise mobility, e-commerce and agile
20 20
-
- -
- - -
- development platforms. Platforms & New Services contributed ~44% to IITS revenue in 4QFY20 per old service classification, not too different from ‘digital’
Sep Sep
Sep revenue (~38%). These services clocked a robust 5.5% USD revenue CQGR over 8 quarters from 4QFY18-4QFY20, implying 24% annualised growth. IP-led revenue
Sep
Mar Mar Mar clocked a robust 8.6% revenue CQGR over 8 quarters from 4QFY18-4QFY20, and accounted for 25.4% of revenue in 4QFY20 and 32.6% in 1QFY21. Thus, IP and P/E multiple chart platforms are a critical differentiating factor for Sonata. M&A activity drives vertical and geographic diversification, expands addressable market 50 Valuation (TTM) In December 2018, Sonata acquired Scalable Data Systems in Australia and Sopris Solutions in the US, while in March 2020, the company acquired GAPbusters LTD, 29.6 UK. These acquisitions have given the company new geographic and vertical diversification, access to an MS Dynamics-based commodity trading platform, and 23.5 17.4 horizontal service diversification into customer experience. Thus, its M&A strategy has enabled it to expand its services into newer verticals, where it can offer its horizontal platforms to drive growth.
0
Valuation
17 19 20 Sonata’s stock trades at a PE of 11.9x/10.7x FY22E/FY23E EPS. We expect Sonata to record >11% USD revenue CAGR in its IITS business over FY21E-FY23E, IITS EBITDA
CAGR of 13.9% (17.3% consolidated EBITDA CAGR) and EPS CAGR of nearly 20% over the period. In context of improving growth, a differentiated business model with
Jun/
Jun/18 Jun/19
Sep/17
Dec/17
Sep/18 Sep/19
Dec/19 Jun/
Dec/18
Mar/ Mar/18 Mar/20 platform focus, marquee acquisitions boosting cash usage and expanding addressable market, and healthy operating metrics – apart from reasonable valuation - PE Average we believe the stock is a good investment option. We Initiate Coverage on Sonata Software with an ACCUMULATE rating and target price of INR 375, valuing the stock at 12x FY23E EPS.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Investment Rationale a) Worst appears to be behind after a difficult 1QFY21, Travel exposure down to just 4% of IITS revenue, key client TUI likely to see pick up • Sonata was one of the worst-hit IT firms in 1QFY21 due to the COVID-19 pandemic, recording a substantial 17.8% QoQ USD revenue decline, as its second-largest client – German travel major TUI Group – suspended operations and most of its IT spend. We expect the IT firm to report much-improved performances from 2QFY21 onward, as economies have gradually opened up and TUI has resumed some of its operations. • TUI Group recently reported its 3QFY20 results (September-ending fiscal year), with the company reporting a severe 98% YoY decline in revenue owing to standstill in operations for a good part of the quarter, with only partial resumption in mid-May. However, 15% of its hotel portfolio reopened during the quarter in specific geographies including Europe, Mexico, the Caribbean and Egypt with social distancing protocols in place. From mid-June, the summer tour operator program was also partially restarted, and operations also resumed in the Benelux region. Thus, operations are resuming, albeit at a gradual pace. • The travel major’s liquidity position appears decent, with cash and available liquidity facilities amounting to €2.4bn as of August 12, 2020, having secured a financial stabilisation package with the German federal government for €1.2bn . Importantly, TUI has clearly specified acceleration of digitisation initiatives in FY21 as a key priority, apart from improving leverage, restoring credit rating and returning to profitability, which we believe will aid Sonata in driving revenues from this client going forward. Sonata’s continuing support to TUI during this phase is likely to pay dividends in the form of the company being a key beneficiary of improved IT and digital spend. • It should be noted that ex-Travel, Sonata’s revenue saw a 1.2% QoQ growth in USD terms, aided by growth in Retail (Essential) and ‘Others’ (+23.3% and +25.5% QoQ). Even on a YoY basis, while reported USD revenue declined 17.6%, this was mainly owing to the steep 86.8% YoY decline in Travel; ex-Travel, revenue rose 5.5% YoY aided by Retail (Essential) and Commodity Business and Services (+64.8% and +23.6% YoY, respectively). The ‘Others’ segment also rose by a robust 40.6% YoY. ‘Others’ essentially comprises of smaller verticals including Energy, Insurance, BFS, Field Services, Real Estate and Staffing. Sonata provides platform services to a US top-3 Energy major, and also serves smaller firms in the other mentioned verticals.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
• In March 2020, the IT firm acquired GAPbusters LTD, UK, a company that focusses on enterprise-level solutions for measuring customer experience. The acquired entity is present in Australia, the UK, US and Asia, and services verticals including Retail, QSRs, Automotive, Electronics and Home Improvement. • Apart from this, Sonata has also acquired minority stakes in various companies to get access to newer skill sets, including buying 15% in a Denmark-based IT consulting firm (IZARA ApS, December 2017), making a strategic investment in a SaaS start- up for offline retailers (Retail10X Inc in March 2019), and acquiring 17% in a US-based technology platform provider to logistics firms (SemiCab Inc, February 2020). • Sonata’s acquisitions are largely more on horizontal lines (MS Dynamics, customer experience), which can enable the IT firm to expand its vertical offerings and hence, addressable market. The company has spent in excess of Rs1.1bn on the acquired companies (~28% of FY20 cash and investments), apart from spending smaller amounts in companies where it has taken minority stakes. We believe such targeted acquisitions will enable Sonata to further drive growth over the longer term. Valuation – Healthy operating metrics, reasonable valuation key positive aspects, Initiate Coverage with ACCUMULATE Sonata’s stock trades at a PE of 11.9x/10.7x FY22E/FY23E EPS. We believe the worst is now behind the company, with 1QFY21 being a trough quarter, mainly owing to the severe decline in Travel revenue led by TUI. With operations slowly resuming, we believe TUI revenue could be at least stable from 2QFY21, with some recovery from 3QFY21 onward. Other key verticals including ISV, Retail (Essential and Non Essential), Distribution & Manufacturing, and Commodities & Services should also see growth returning. It should be noted that while the company’s IITS revenue saw a severe impact in 1QFY21, margin performance was impressive, with the IT firm reporting a healthy 385bps QoQ EBITDA margin improvement, with margins likely to remain within a range. Sonata enjoys healthy operating metrics, with impressive IITS EBITDA margin of >22% (better than most mid sized IT firms), gross debt-equity ratio at a very conservative 0.1x (net cash positive), interest coverage ratio of >22x in FY20, no equity dilution since April 2001, operating cash flow well in excess of 100% and RoE consistently in excess of 30% since FY15. We expect Sonata to record >11% USD revenue CAGR in its IITS business over FY21E-FY23E, IITS EBITDA CAGR of 13.9% (17.3% consolidated EBITDA CAGR) and EPS CAGR of nearly 20% over the period. Thus, in context of improving growth, a differentiated business model with platform focus, marquee acquisitions boosting cash usage and expanding addressable market, and healthy operating metrics – apart from reasonable valuation - we believe the stock is a good investment option. We Initiate Coverage on Sonata Software with an ACCUMULATE rating and target price of INR 375, valuing the stock at 12x FY23E EPS.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Exhibit 1: Profit & Loss Statement Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E IITS Revenue (USD mn) 161.2 180.8 153.7 172.9 190.2 Cons. Revenue 29,609 37,433 38,719 42,878 47,166 Total operating expenses 26,253 33,705 35,491 38,837 42,721 EBITDA 3,356 3,728 3,228 4,041 4,445 Depreciation & Amortisation 127 365 411 446 469 EBIT 3,229 3,363 2,818 3,595 3,976 Interest Cost 34 152 132 96 77 Other Income 273 584 292 409 435 PBT 3,467 3,795 2,978 3,907 4,333 Income tax 1,006 1,026 715 977 1,083 PAT before minority interest 2,461 2,769 2,263 2,931 3,250 Minority interest -4 0 0 0 0 Exceptional items 28 0 0 0 0 PAT after minority interest 2,493 2,769 2,263 2,931 3,250 Diluted EPS (INR) 24.0 26.7 21.8 28.2 31.3
Exhibit 2: Cash Flow Statement Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E Net cash generated from Operations -158 3,724 2,640 2,682 3,509 Net cash flow from Investing Activities 113 1,391 -290 -322 -377 Net cash flow from Financing Activities -1,630 -2,837 -1,918 -2,167 -1,995 Net inc/(dec) in cash equivalents -1,675 2,278 432 194 1,137 Opening balance 3,474 1,992 3,964 4,396 4,590 Other adjustments 193 -306 0 0 0 Closing cash and cash equivalents 1,992 3,964 4,396 4,590 5,727
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Exhibit 3: Balance Sheet Exhibit 4: Ratio Analysis Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E Particulars FY19 FY20 FY21E FY22E FY23E Equity share capital 104 104 104 104 104 Reserves 7,579 6,593 7,111 8,046 9,301 Tax rate (%) 29.0 27.0 24.0 25.0 25.0 Net worth 7,683 6,697 7,214 8,150 9,405 Borrowings 156 860 688 516 516 RoE (%) 35.1 38.5 32.5 38.1 37.0 Operating lease liability - 211 211 211 211 Other liabilities 435 1,068 1,068 1,068 1,068 RoCE (%) 31.5 33.8 30.8 35.1 34.0 Accounts payable 5,873 5,619 5,834 5,852 6,437 Current ratio (x) 1.8 1.6 1.7 1.8 1.9 Other current liabilities 523 1,122 1,104 1,108 1,110 Provisions 611 589 480 572 609 EBITDA margin (%) 11.3 10.0 8.3 9.4 9.4 Total current liabilities 7,007 7,329 7,418 7,532 8,156 Total Liabilities 15,281 16,165 16,599 17,477 19,356 EBIT margin (%) 10.9 9.0 7.3 8.4 8.4 Gross block 471 539 830 1,151 1,529 Depreciation 251 326 653 1,014 1,441 Net profit margin (%) 8.4 7.4 5.8 6.8 6.9 Net block 220 213 177 137 88 Capital work in progress 6 - - - - PE ratio (x) 14.0 12.6 15.4 11.9 10.7 Goodwill and Intangible assets 1,774 1,796 1,711 1,627 1,585 Non current investments 62 87 87 87 87 EV/EBITDA (x) 9.9 8.3 9.4 7.5 6.5 Deferred tax assets, net 119 244 244 244 244 EV/EBIT (x) 10.3 9.2 10.8 8.4 7.3 Right of use assets - 973 973 973 973 Other non current assets 632 956 956 956 956 Accounts receivable 8,111 7,000 7,001 7,636 8,399 Unbilled revenue 447 408 529 703 773 Short term loans and advances 11 17 17 17 17 Current investments 1,402 48 48 48 48 Cash and bank 1,992 3,964 4,396 4,590 5,727 Other current assets 505 458 458 458 458 Total current assets 12,468 11,896 12,450 13,452 15,423 Total Assets 15,281 16,165 16,599 17,477 19,356
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Relative performances in 1QFY21 – Persistent by far the best
(%, QoQ) Best of the lot, achieving growth even in a COVID quarter 5 3.1
0 -1.2 -5 -3.5 -6.8 -10 -9.1 -8.7
-15 -12.5 -12.5 -15.2 -20 -17.8 Mindtree Hexaware Persistent Coforge* Birlasoft Sonata** Cyient L&T Tech. Tata Elxsi KPIT Tech. EBIT margin – Steady improvement over the past 2 quarters, scope for further rise
(%)
12
11 10.4 9.8 10 9.2 8.9 9 8.7
8
7 1QFY20 1QFY20 1QFY20 1QFY20 1QFY20
Source: Company Reports, KRChoksey Research; * In INR terms; ** For Sonata’s IITS business
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Technology Services – The key revenue growth driver from a service line perspective
(US$ mn) (%)
105 10 101.0 98.8 100 94.9 7 5.1 95 4.5 4.2 4 90.2 2.2 90 86.4 1 85 -2 -2.9 80 -5 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 Technology Services revenue QoQ growth (RHS)
BFSI – The key revenue growth driver from a vertical perspective
(US$ mn) (%)
45 15 39.5 41.7 42 12 10.7 39.8 39 7.6 9 35.6 36 6 33.1 4.8 33 3.7 3
30 0.7 0 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 BFSI revenue QoQ growth (RHS)
Source: Company Reports, KRChoksey Research
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Revenue – Healthy double digit growth likely, led by strategy pivot, large deal wins
(US$ mn) (%)
700 681.2 15 613.9 640 11.7 12 9.6 11.0 580 549.7 9
520 501.6 6 4.3 460 3
400 0 FY20 FY21E FY22E FY23E Revenue Revenue growth (RHS) EBIT, margins – Expansion likely, aided by revenue growth
(INR mn) (%)
6,000 5,748 12 11.3 5,400 5,202 11.3 11 10.6 4,800 10 4,374 4,200 9.2 9
3,600 3,270 8 3,000 7 FY20 FY21E FY22E FY23E EBIT EBIT margin (RHS)
Source: Company Reports, KRChoksey Research
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
EPS – Decent growth outlook, aided by industry-leading revenue performance
(INR) (%)
70 67.2 20 18.6 61.1 64 15.8 16
58 12 52.8 9.8 52 8
46 44.5 4
40 0.2 0 FY20 FY21E FY22E FY23E EPS EPS growth (RHS)
Source: Company Reports, KRChoksey Research
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
CMP Target Potential Upside Market Cap (INR Mn) Recommendation Sector INR 1,226 INR 1,340 9.3% INR 93,430 ACCUMULATE Information Technology
About the company • Persistent is a Pune-based IT firm that offers a range of IT services and product development to clients ranging from AI, machine learning, cloud services, product engineering and digital platforms & solutions. The company is a horizontal-focused service provider, with its digital service offerings and product engineering business services applicable across a range of industries including BFSI, Healthcare, Industrial and Software & Hi-tech. The company counts IBM as its largest client and key strategic partner. Geography-wise, Persistent earns a lion’s share of its revenue from North America (80.4% in 1QFY21), followed by Europe (10.2%), India (7.9%) and Rest of the World (1.5%). The company employed nearly 11,000 people as of 1QFY21-end. Persistent has grown revenue, EBIT and PAT at CAGRs of 13.5%, 2.0% and 3.2%, respectively over the period FY15-FY20.
MARKET DATA KEY FINANCIALS Shares outs (Mn) 76 Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E Equity Cap (INR Mn) 764.25 Revenue (USD Mn) 481 502 550 614 681 Mkt Cap (INR Mn) 93,430 Revenue 33,659 35,658 41,317 46,044 51,088 52 Wk H/L (INR) 1239.00/420.00 EBIT 4,233 3,270 4,374 5,202 5,748 Volume Avg (3m K) 212.10 Face Value (INR) 10 FDEPS (INR) 44.4 44.5 52.8 61.1 67.2 Bloomberg Code PSYS IN EBIT margin (%) 12.6 9.2 10.6 11.3 11.3 PE ratio (x) 27.6 27.5 23.2 20.0 18.3 SHARE PRICE PERFORMANCE EV/EBIT (x) 21.3 27.3 19.9 16.5 14.7
200 Persistent Sensex Investment Rationale One of the best performers in a COVID-hit quarter, new strategy paying dividends 150 Persistent reported an excellent 3.1% QoQ USD revenue growth in 1QFY21, easily among the best performances compared with most of its peers in the IT industry. The company’s performance was aided by deal wins, a vendor consolidation deal going in its favour and growth in Alliance revenue led by reseller business. On profitability, Persistent clocked a 100 healthy 113bps QoQ EBIT margin expansion, aided by revenue growth, cost control and favourable currency movement. Management is optimistic on growth prospects for 2QFY21. We expect Persistent to report >11% USD revenue CAGR over FY21-FY23E, on top of nearly 10% growth in FY21, amongst the highest in the industry. This has been led by key 50 strategic changes made by ex-CEO Chris O’Connor (who recently quit in August 2020), notably implementing a solutions-led approach to effectively mine top accounts and win larger deals, realigning verticals and service lines to effectively map client IT spends to its own portfolio of service offerings, and bringing in key senior management personnel at critical positions including President of Technology Services Sandeep Kalra (likely the next CEO) and CMO Keith Landis.
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Pivot under previous CEO drives improvement in performance, continuity critical as and when new CEO comes on-board
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------Under previous CEO Chris O’Connor, Persistent has pivoted its business model towards managed services, annuity revenue, technology services business and large deals, mapping
client IT spend to its own portfolio of offerings. The results were seen in 1QFY21 performance, with revenue growth the best among peers. Going forward, we would look for
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Mar Mar Mar strategy continuity under the new CEO, given the rebound in growth and profitability that has been witnessed by the company with its new strategic direction. Appointment of a P/E multiple chart new CEO is likely to be a critical event that will determine medium-term financial and stock performance for Persistent. Partnerships and collaborations to drive growth in critical segments 50 Valuation (TTM) Persistent’s key partnerships with major strategic partners are likely to drive growth for the mid-sized IT firm in critical areas like digital, cloud and its Alliances business. On the cloud front, Persistent has tie-ups with all the major cloud providers, including Amazon AWS, Microsoft Azure, Google Cloud and IBM Cloud. IBM remains Persistent’s top client by 29.6 far (17.7% of revenue in 1QFY21). IBM is also a strategic partner of Persistent where the company sells integrated offerings along with software sale. Persistent has also opened a 23.5 17.4 Centre of Excellence with Red Hat to accelerate application modernisation on hybrid cloud. The company has expanded its partnership with Dassault Systèmes, which will help clients to reduce costs, improve supplier collaboration, drive agility and gather better field insights for future product iterations and customer support.
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Valuation
17 18 20 Persistent’s stock trades at 20.0x/18.3x FY22E/FY23E EPS, respectively at current levels. We are enthused by the pivot under the earlier CEO towards managed services, annuity
revenue, technology services business and large deals, driven by service line and vertical realignment to effectively map client IT spend to its portfolio of offerings. While near-term
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Mar/19 Mar/18 Mar/ margin pressure could be seen owing to transition costs in large deals, this can be recouped with revenue growth. We would also watch trade receivables, given the rise seen in PE Average 1QFY21, which impacted cash conversion. We expect 11.3% USD revenue CAGR over FY21-FY23E after a 9.6% growth in FY20, and 12.8% EPS CAGR over the period after 18.6% growth in FY20. We maintain “ACCUMULATE” on Persistent with an upwardly revised target price of INR 1,340, implying a target PE of 20x FY23E EPS.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Investment Rationale a) One of the best performers in challenging 1QFY21 COVID-hit quarter, growth outlook robust
• Persistent Systems reported an excellent 3.1% QoQ USD revenue growth in 1QFY21, easily among the best performances compared with most of its peers in the IT industry, with most mid tier and top tier peers reporting sequential revenue declines, in some cases double digit declines for ER&D firms like Cyient and LTTS.
• The company’s impressive 1QFY21 performance was aided by deal wins, a vendor consolidation deal going in its favour and growth in Alliance revenue led by reseller business.
• From a vertical perspective, Persistent’s growth was aided by services and the reseller channel, with BFSI and Healthcare clocking healthy growth among the verticals, aided by deal ramp ups.
• On the profitability side, Persistent clocked a healthy 113bps QoQ EBIT margin expansion, aided by revenue growth, cost control and favourable currency movement.
• Management is optimistic on growth prospects for 2QFY21, although it should be noted that in light of the as-yet fluid global economic scenario, with the COVID-19 pandemic far from finished, there could be some volatility in financial performances.
• We expect Persistent to report >11% USD revenue CAGR over FY21-FY23E, on top of nearly 10% growth in FY21, amongst the highest in the industry. This has been led at a broader level by key strategic changes made by ex-CEO Chris O’Connor (who recently quit in August 2020), notably implementing a solutions-led approach to effectively mine top accounts and win larger deals, realigning verticals and service lines to effectively map client IT spends to its own portfolio of service offerings, and bringing in key senior management personnel at critical positions including President of Technology Services Sandeep Kalra (likely the next CEO) and CMO Keith Landis.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
• Under the previous CEO Chris O’Connor, Persistent has pivoted its business model towards managed services, annuity revenue, the technology services business and large deals, driven by a realignment of service lines and verticals to effectively map client IT spend to its own portfolio of offerings.
• Persistent realigned its Technology Services business this year, merging its Accelerite product business with the segment, which will aid in cross-selling services to clients that use its enterprise products, boosting growth of the combined business, given that standalone enterprise products is typically a mid single digit growth area.
• The results of the realignment were apparent in 1QFY21, with the company winning a US$ 50mn 5-year BFSI deal in a consolidation exercise by the client, as well as a few multi-million- dollar deals that will reflect in revenue over the next few quarters across new and existing customers. In addition to the BFSI deal, it also won contracts from 3 other BFSI clients and 3 life sciences clients.
• Segment-wise, even as the Alliances business has struggled to grow revenue (USD revenue down 9.8% YoY in 1QFY21), Technology Services clocked healthy growth (17% YoY USD revenue growth in 1QFY21, USD revenue CQGR of 4% over 1QFY20- 1QFY21), aided by service and vertical realignment, cross-sell and up-sell and large deal wins.
• Going forward, we would look for strategy continuity under the new CEO, as and when it is announced, given the rebound in growth and profitability that has been witnessed by the company with its new strategic direction. Appointment of a new CEO is likely to be a critical event that will determine medium-term financial and stock performance for Persistent.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Persistent’s stock trades at 20.0x/18.3x FY22E/FY23E EPS at current levels. We are enthused by the pivot under the earlier CEO towards managed services, annuity revenue, technology services and large deals, driven by service line and vertical realignment to effectively map client IT spend to its portfolio of offerings. This has led to improved revenue and margin performance over the past few quarters, no more so than in 1QFY21, a quarter when most peers reported revenue declines. Deal wins have also been healthy, with Persistent winning a US$ 50mn deal with a leading enterprise software firm in the data virtualisation space, with growth visibility aided further by good traction in its digital banking products in BFSI, and initiatives in Healthcare. While near-term margin pressure could be seen owing to transition costs in large deals, this can be recouped with revenue growth. We would also watch trade receivables, given the rise seen in 1QFY21, which impacted cash conversion. We expect 11.3% USD revenue CAGR over FY21- FY23E after a 9.6% growth in FY20, and 12.8% EPS CAGR over the period after 18.6% growth in FY20. We maintain “ACCUMULATE” on Persistent with an upwardly revised target price of INR 1,340, implying a target PE of 20x FY23E EPS.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Exhibit 1: Profit & Loss Statement Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E Revenue (USD mn) 481 502 550 614 681 Revenue 33,659 35,658 41,317 46,044 51,088 Employee cost 21,378 23,494 27,439 30,316 34,010 SG&A and other expenses 6,476 7,234 7,719 8,746 9,383 EBITDA 5,805 4,929 6,159 6,982 7,696 Depreciation & Amortisation 1,573 1,660 1,785 1,780 1,948 EBIT 4,233 3,270 4,374 5,202 5,748 Interest Cost 0 0 0 0 0 Other Income 631 1,254 1,028 1,029 1,097 PBT 4,863 4,523 5,402 6,231 6,845 Income tax 1,347 1,121 1,366 1,558 1,711 RPAT 3,517 3,403 4,036 4,673 5,134 Diluted EPS (INR) 44.4 44.5 52.8 61.1 67.2
Exhibit 2: Cash Flow Statement
Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E Net cash generated from Operations 4,842 4,100 4,177 4,925 5,463 Net cash flow from Investing Activities 6,912 -234 471 -352 -436 Net cash flow from Financing Activities -7,513 -4,211 -2,511 -3,258 -3,579 Net inc/(dec) in cash equivalents 4,241 -344 2,137 1,314 1,448 Opening balance 2,414 6,724 4,572 6,709 8,023 Other adjustments 69 -1,808 0 0 0 Closing cash and cash equivalents 6,724 4,572 6,709 8,023 9,472
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Exhibit 3: Balance Sheet Exhibit 4: Ratio Analysis
Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E Particulars FY19 FY20 FY21E FY22E FY23E Equity share capital 791 764 764 764 764 Reserves 22,656 23,093 24,784 26,200 27,754 Tax rate (%) 27.7 24.8 25.3 25.0 25.0
Net worth 23,447 23,858 25,549 26,964 28,518 RoE (%) 15.3 13.7 15.8 17.0 17.6 Borrowings 12 46 46 46 46 Long term liabilities and provisions 253 536 536 536 536 RoCE (%) 15.0 13.5 15.5 16.7 17.3
Accounts payable 1,517 2,247 2,571 2,857 3,173 Current ratio (x) 3.9 3.1 3.4 3.5 3.7 Other current liabilities 1,641 2,624 2,624 2,624 2,624 Provisions 1,686 1,611 1,611 1,611 1,611 EBITDA margin (%) 17.2 13.8 14.9 15.2 15.1
Total current liabilities 4,844 6,482 6,806 7,091 7,408 EBIT margin (%) 12.6 9.2 10.6 11.3 11.3 Total Liabilities 28,556 30,922 32,937 34,637 36,508 Net block 2,331 2,225 1,163 764 349 Net profit margin (%) 10.4 9.5 9.8 10.1 10.0
Capital work in progress 12 166 166 166 166 PE ratio (x) 27.6 27.5 23.2 20.0 18.3 Goodwill and Intangible assets 1,677 1,524 1,524 1,524 1,524 Intangible assets under development 304 137 137 137 137 EV/EBITDA (x) 15.6 18.1 14.1 12.3 10.9
Non current investments 4,346 4,621 4,621 4,621 4,621 EV/EBIT (x) 21.3 27.3 19.9 16.5 14.7 Deferred tax assets, net 405 960 960 960 960 Right of use assets - 567 567 567 567 Other non current assets 582 891 891 891 891 Accounts receivable 4,923 5,922 6,862 7,647 8,485 Short term loans and advances 8 14 14 14 14 Current investments 3,296 5,165 5,165 5,165 5,165 Cash and bank 6,724 4,572 6,709 8,023 9,472 Other current assets 3,950 4,159 4,159 4,159 4,159 Total current assets 18,900 19,831 22,908 25,007 27,293 Total Assets 28,556 30,922 32,937 34,637 36,508
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Transportation revenue – JLR-led revenue decline
(INR mn) (%)
2,000 15 1,917 1,893 1,852 10.4 1,880 9.4 9.2 8 1,788 1,805 1,752 1,760 0.9 1 -1.3 -2.2 1,619 1,640 -6 1,516 1,520 1,483 -13 -16.0 1,400 -19.9 -20 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 Transportation revenue QoQ growth (RHS) Transportation % of EPD revenue – Consistent decline reduces dependence
(%) 54.9 55 53.4 53.7 53.4
52 48.6 49 48.3 46.6 47.1 46
43 42.1
40 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21
Source: Company Reports, KRChoksey Research
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
JLR revenue – Company-specific issues, COVID-19 drives reduced dependence
(INR mn) (%) 982 1,000 934 30 895 25.7 863 880 23.2 24 22.0 21.3 760 665 689 18 16.7 16.3 629 15.7 15.7 640 604 12.1 12
520 485 6
400 0 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 Top client revenue % of total revenue (RHS) Broadcast and Communications – Robust growth, fueled by marquee clients, favourable trends
(%) (INR mn) 3.9% CQGR
1,650 1,620 50 1,567 1,550 47 1,442 45.0 1,450 44 1,315 1,371 41.3 1,350 1,279 40.9 40.9 41 1,233 1,248 39.2 1,250 1,191 38 36.3 36.3 36.0 1,150 35.3 35 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 Broadcast & Comm revenue % of EPD revenue (RHS)
Source: Company Reports, KRChoksey Research
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Healthcare & Medical Devices – Positive industry trends, low base power growth
(INR mn) 14.5% CQGR (%)
350 10 310 305 295 300 8 245 250 218 6 200 180 4 159 140 150 2 105 100 0 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 Healthcare & Med revenue % of EPD revenue (RHS) Revenue growth – Non-transportation verticals to drive double digit growth
(INR mn) (%)
22,500 21,593 15
21,000 11.7 12 11.0 19,500 9.6 18,948 9
18,000 6 16,833 4.3 16,500 16,099 3
15,000 0 FY20 FY21E FY22E FY23E Revenue Revenue growth (RHS)
Source: Company Reports, KRChoksey Research
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
EBIT, margin – Revenue growth, effective cost management to drive improvement
(INR mn) (%) 4,544 4,600 22
4,260 21.0 21 20.7 20.4 3,931 3,920 20
3,580 3,426 19 18.6 3,240 18 2,996 2,900 17 FY20 FY21E FY22E FY23E EBIT EBIT margin (RHS) EPS – Healthy double digit growth to be aided by revenue growth, margin improvement
(INR) (%) 59.5 60 14.3 15 12.0 13.0 56 9 52.1 52 3
48 46.1 -3
44 41.1 -9 -11.7 40 -15 FY20 FY21E FY22E FY23E EPS EPS growth (RHS) Source: Company Reports, KRChoksey Research
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
CMP Target Potential Upside Market Cap (INR Mn) Recommendation Sector INR 1,199 INR 1,308 9.1% INR 75,028 ACCUMULATE Information Technology
About the company Tata Elxsi is a provider of design and technology services across industries including Automotive, Broadcast, Communications and Healthcare. The company enables its clients to transform their business and provides services through design thinking and application of digital technologies such as IoT, Cloud, Mobility, Virtual Reality and Artificial Intelligence. The company counts Tata Group-owned UK-based luxury auto major JLR as its largest client. Geography-wise, Persistent earns a lion’s share of its revenue from the US (36.0% in 1QFY21), followed by Europe (35.8%), Rest of the World (15.1%) and India (13.1%). The company employed >6,600 people as of 1QFY21-end. Tata Elxsi has grown revenue, EBIT and PAT at CAGRs of 13.6%, 14.6% and 20.0%, respectively over the period FY15-FY20. MARKET DATA KEY FINANCIALS Shares outs (Mn) 62 Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E Equity Cap (INR Mn) 622.76 Revenue 15,969 16,099 16,833 18,948 21,593 Mkt Cap (INR Mn) 75,028 EBIT 3,899 2,996 3,426 3,931 4,544 52 Wk H/L (INR) 1330.00/501.00 Volume Avg (3m K) 641.91 FDEPS (INR) 46.6 41.1 46.1 52.1 59.5 Face Value (INR) 10 EBIT margin (%) 24.4 18.6 20.4 20.7 21.0 Bloomberg Code TELX IN PE ratio (x) 25.8 29.2 26.0 23.0 20.2 EV/EBIT (x) 17.8 22.7 19.4 16.6 14.0 SHARE PRICE PERFORMANCE Investment Rationale Vertical diversification to drive de-risking of business Tata Elxsi’s diversification and de-risking initiatives are shaping up well, with the Transportation vertical contributing ~42% to total EPD revenue in 1QFY21 vs. 46.6% in 1QFY20; this is 200 the lowest contribution since the company started disclosing vertical break up data from 1QFY19. The non-Transportation part of Tata Elxsi’s business has grown at a healthy clip of 150 3.9% CQGR over 1QFY19-1QFY21 (17% annualised growth), with Broadcast & Communications clocking a similar growth, while Healthcare & Medical Devices growing at a robust 14.5% CQGR over the period (72% annualised growth). We expect Tata Elxsi to clock 13.3% revenue CAGR over FY21-FY23E, after factoring 4.6% growth in FY21, 15.2% EBIT CAGR over 100 the period after 14.4% growth in FY21, and 13.6% EPS CAGR after 12% growth in FY21. Growth will be led by Broadcast & Communications and Healthcare & Medical Devices verticals, 50 with Transportation likely to see recovery from FY22, while margin is likely to be led by revenue growth and cost control, particularly on expenses such as travel. Broadcast & Communications the key growth driver, led by favourable trends
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Going forward, we expect Broadcast & Communications to be the key growth driver from a vertical perspective. This vertical has clocked a healthy 3.9% revenue CQGR over
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20 1QFY19-1QFY21 (17% annualised growth) and accounted for 45% of EPD revenue, its highest-ever level and the first time it accounted for higher revenue share than Transportation.
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Dec Sep Mar players & devices (like set-top boxes etc). From a client profile perspective, Tata Elxsi’s top account is a large US-based multi-services operator. The company also counts well- Tata Elxsi Sensex known Indian firms such as Airtel TV among its OTT clients. We are enthused with Tata Elxsi’s differentiated service offerings in a high-growth vertical that is seeing favourable trends, and expect Broadcast & Communications to clock double digit growth across the next few years in light of these structurally favourable trends. P/E multiple chart Margins likely to see upward trend, aided by revenue growth, cost control We expect Tata Elxsi to report a healthy 243bps improvement in EBIT margins over FY20-FY23, with a substantial part of the expansion likely to come in FY21 (174bps), followed by 50 Valuation (TTM) 30-35bps annual expansion over FY21-FY23. Improved revenue growth, aided by bottoming of Transportation vertical and robust performances of Broadcast & Communications and Healthcare & Medical Devices verticals is likely to be the key driver of margin expansion. On the cost side, Tata Elxsi is likely to focus on limiting key cost items such as travel, 29.6 23.5 along with general operational efficiency. We model for EBIT margin to rise to 21% in FY23 vs 18.6% in FY20, with EBIT in absolute terms likely to grow at a healthy 15% CAGR over the 17.4 period. Valuation
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Tata Elxsi’s stock currently trades at a P/E multiple of 23.0/20.2 FY22E/FY23E EPS, respectively. Improving vertical mix diversification, near-term margin expansion, relevant service
17 18 20 portfolio in fast-growing areas of IT spend such as embedded software, automotive electronics, AR/VR, OTT media and medical devices, and healthy double digit EPS growth (14%
Jun/ CAGR over FY21-FY23E) underpin our positive stance on the specialised IT firm. We value the stock at 22x FY23E EPS and arrive at a revised target price of INR 1,308 (INR 1,064
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Mar/19 Mar/18 Mar/ earlier) as we factor in FY23E earnings. We retain our “ACCUMULATE” rating on the stock and believe the recent 8% correction is a good opportunity for investors to add to PE Average their portfolio. •
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Investment Rationale a) Vertical diversification to continue business de-risking • Tata Elxsi’s diversification and de-risking initiatives are shaping up well, with the Transportation vertical contributing ~42% to total EPD revenue in 1QFY21 vs. 46.6% in 1QFY20; this is the lowest contribution since the company started disclosing vertical break up data from 1QFY19. General slowdown in the European automotive sector, coupled with slowing economic activity owing to COVID-19 lockdown has been a drag on the European business, with Europe contributing 35.8% to total revenue in 1QFY21 vs 42.6% contribution in 1QFY20. • Transportation vertical revenue has clocked 1.8% CQGR decline over 1QFY19-1QFY21, led by weak Auto demand in Europe, slow deal progress from key customers, COVID-19 impact and growth headwinds from top client JLR; JLR revenue has clocked a steep 8.4% CQGR decline over 1QFY19-1QFY21, and accounted for 12.1% of total revenue in 1QFY21, its lowest-ever contribution. This has been a mix of offshoring (20%) and reduction in JLR’s overall budget (80%). The recovery will also be prolonged and is expected to be witnessed from 2HFY21. • Tata Elxsi is consciously looking at adjacent industries to automotive OEMs and Tier-1 auto players such as rail, off-road, and commercial markets. These adjacent markets need similar skillsets to automotive and offer greater utilisation of existing bandwidth in sales and delivery. Several new tier-1 customers have been onboarded in the past 2-3 quarters in verticals like off-road and rail, to reduce the dependence on Transportation vertical. • The non-Transportation part of Tata Elxsi’s business has grown at a healthy clip of 3.9% CQGR over 1QFY19-1QFY21 (17% annualised growth), with Broadcast & Communications clocking a similar growth, while Healthcare & Medical Devices growing at a robust 14.5% CQGR over the period (72% annualised growth). • We expect these verticals to continue to clock healthy growth for Tata Elxsi as the Transportation business takes its time to recover from the COVID-19 pandemic, with favourable trends in both Broadcast & Communications (healthy growth in OTT platforms and bandwidth usage) and Healthcare & Medical Devices likely to ensure robust IT and technology spend at the client’s end. • We expect Tata Elxsi to clock 13.3% revenue CAGR over FY21-FY23E, after factoring 4.6% growth in FY21, 15.2% EBIT CAGR over the period after 14.4% growth in FY21, and 13.6% EPS CAGR after 12% growth in FY21. Growth will be led by Broadcast & Communications and Healthcare & Medical Devices verticals, with Transportation likely to see recovery from FY22, while margin is likely to be led by revenue growth and cost control, particularly on expenses such as travel.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
• Going forward, given growth headwinds in the Transportation segment, which have gotten exacerbated owing to COVID-19, we expect Broadcast & Communications to be the key growth driver from a vertical perspective.
• This vertical has clocked a healthy 3.9% revenue CQGR over 1QFY19-1QFY21 (17% annualised growth) compared with just 1.2% total EPD revenue CQGR, and accounted for 45% of EPD revenue, its highest-ever level and the first time it accounted for higher revenue share than Transportation.
• Broadcast & Communications accounted for >130% of Tata Elxsi’s incremental EPD revenue over 1QFY19-1QFY21, indicating that it added even greater incremental revenue that total EPD revenue, with Transportation revenue seeing a steep decline in absolute terms over the period.
• Tata Elxsi is seeing increasing traction across key sub-segments of the Broadcast & Communications vertical, including operators (focussing in the US, Europe, SA, & ME), OTT players & devices (like set-top boxes etc).
• From a client profile perspective, Tata Elxsi’s top account is a large US-based multi-services operator, with the relationship being fairly recent (>1 year). The company also counts well-known Indian firms such as Airtel TV among its OTT clients.
• We are enthused with Tata Elxsi’s differentiated service offerings in a high-growth vertical that is seeing favourable trends, and expect Broadcast & Communications to clock double digit growth across the next few years in light of these structurally favourable trends.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
• We expect Tata Elxsi to report a healthy 243bps improvement in EBIT margins over FY20-FY23, with a substantial part of the expansion likely to come in FY21 (174bps), followed by 30-35bps annual expansion over FY21-FY23.
• Improved revenue growth, aided by bottoming of Transportation vertical and robust performances of Broadcast & Communications and Healthcare & Medical Devices verticals is likely to be the key driver of margin expansion.
• On the cost side, Tata Elxsi is likely to focus on limiting key cost items such as travel, along with general operational efficiency, which will further boost the margin profile.
• We model for EBIT margin to rise to 21% in FY23 vs 18.6% in FY20, with EBIT in absolute terms likely to grow at a healthy 15% CAGR over the period. Our EBIT margin estimate for FY23 is still well below the levels achieved in FY18 and FY19 (23-24%), in years when its top client JLR was witnessing healthy growth and the non-Transportation verticals were also growing at a fast clip on a low base. Valuation – De-risking business profile continues, greater share of non-Transportation enthusing, but valuation full; we downgrade to HOLD
Tata Elxsi’s stock currently trades at a P/E multiple of 23.0x/20.2x FY22E/FY23E EPS, respectively. Improving vertical mix diversification, near-term margin expansion, relevant service portfolio in fast-growing areas of IT spend such as embedded software, automotive electronics, AR/VR, OTT media and medical devices, and healthy double digit EPS growth (14% CAGR over FY21-FY23E) underpin our positive stance on the specialised IT firm. We value the stock at 22x FY23E EPS and arrive at a revised target price of INR 1,308 (INR 1,064 earlier) as we factor in FY23E earnings. We retain our “ACCUMULATE” rating on the stock and believe the recent 8% correction is a good opportunity for investors to add to their portfolio.
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Exhibit 1: Profit & Loss Statement Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E Revenue 15,969 16,099 16,833 18,948 21,593 Total operating expenses 11,819 12,669 12,968 14,560 16,580 EBITDA 4,150 3,430 3,865 4,388 5,013 Depreciation & Amortisation 251 434 439 456 469 EBIT 3,899 2,996 3,426 3,931 4,544 Interest Cost 0 56 58 55 52 Other Income 435 584 615 626 653 PBT 4,334 3,524 3,983 4,502 5,144 Income tax 1,434 963 1,115 1,261 1,440 RPAT 2,900 2,561 2,868 3,242 3,704 Diluted EPS (INR) 46.6 41.1 46.1 52.1 59.5
Exhibit 2: Cash Flow Statement
Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E Net cash generated from Operations 2,341 2,839 2,786 2,797 3,039 Net cash flow from Investing Activities -290 -389 -252 -237 -216 Net cash flow from Financing Activities -826 -1,021 -1,032 -1,167 -1,333 Net inc/(dec) in cash equivalents 1,225 1,429 1,501 1,393 1,489 Opening balance 3,943 5,158 6,642 8,143 9,536 Other adjustments -11 55 0 0 0 Closing cash and cash equivalents 5,158 6,642 8,143 9,536 11,026
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
Exhibit 3: Balance Sheet Exhibit 4: Ratio Analysis
Particulars (INR Mn) FY19 FY20 FY21E FY22E FY23E Particulars FY19 FY20 FY21E FY22E FY23E Equity share capital 623 623 623 623 623 Reserves 8,805 10,278 12,113 14,188 16,558 Tax rate (%) 33.1 27.3 28.0 28.0 28.0 Net worth 9,428 10,900 12,736 14,810 17,181 Borrowings - - - - - RoE (%) 34.5 25.2 24.3 23.5 23.2 Lease Liabilities - 450 450 450 450 Long term liabilities and provisions 124 366 366 366 366 RoCE (%) 31.0 21.4 20.9 20.6 20.5 Accounts payable 555 471 426 439 454 Other current liabilities 1,244 1,602 1,602 1,602 1,602 Current ratio (x) 5.4 5.5 6.6 7.6 8.7 Provisions 84 101 103 116 132 EBITDA margin (%) 26.0 21.3 23.0 23.2 23.2 Total current liabilities 1,882 2,174 2,131 2,156 2,188 Total Liabilities 11,434 13,890 15,683 17,782 20,184 EBIT margin (%) 24.4 18.6 20.4 20.7 21.0 Gross block 2,623 3,007 3,260 3,497 3,713 Depreciation 1,750 2,185 2,623 3,079 3,548 Net profit margin (%) 18.2 15.9 17.0 17.1 17.2 Net block 872 823 637 417 165 Capital work in progress 4 9 9 9 9 PE ratio (x) 25.8 29.2 26.0 23.0 20.2 Goodwill and Intangible assets 139 129 129 129 129 Intangible assets under development - - - - - EV/EBITDA (x) 16.7 19.8 17.2 14.8 12.7 Non current investments - - - - - Deferred tax assets, net 60 88 88 88 88 EV/EBIT (x) 17.8 22.7 19.4 16.6 14.0 Right of use assets - 518 518 518 518 Long term loans and advances 278 310 310 310 310 Accounts receivable 3,565 3,924 4,243 4,932 5,798 Short term loans and advances 8 9 9 9 9 Inventory 17 17 17 17 17 Cash and bank 5,158 6,642 8,143 9,536 11,026 Other current assets 1,332 1,420 1,579 1,816 2,115 Total current assets 10,080 12,012 13,991 16,310 18,965 Total Assets 11,434 13,890 15,683 17,782 20,184
ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS
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ANALYST KRChoksey Research Phone: +91-22-6696 5555, Fax: +91-22-6691 9576 Harit Shah, [email protected], +91-22-6696 5555 is also available on Bloomberg KRCS