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KPIT Cummins Infosystems (KPIT) is a mid-tier domain-focused IT company, which is riding on the recovery of its anchor vertical, i.e., manufacturing. The company is back to reporting an 8.7% CQGR in its revenue over 2QFY2010–2QFY2011, after recording a decline of 9% CQGR over 2QFY2009–1QFY2010. We expect the company to post a revenue CAGR of 24.9% (USD terms) and 21.7% (INR
terms) over FY2010–13E, with EBITDA and PAT expected to grow at a CAGR of 14.4% and 20.2%, respectively. At the CMP of `136, the stock is trading at attractive valuations of 9.0x FY2012E EPS of `15.1 and 7.5x FY2013E of `18.2, respectively. Over the past five years, KPIT has traded at a one-year forward
median P/E(x) of 12x and in the range of 6–17x. We Initiate Coverage on the stock with a Buy recommendation, valuing the company at 9x FY2013 EPS (i.e. at ~55% discount to Infosys’ FY2013 target P/E) with a Target Price of `164.
Niche focus to be a revenue driver: Globally, the green shoots of recovery in the manufacturing business have propelled growth for the company over the recent quarters. Going forward, we believe KPIT will witness revenue growth once 1) the global automobile sector returns to higher growth, 2) manufacturing vertical increasingly starts spending on discretionary IT services to go-to-market and drive cost efficiencies and 3) the top-client, Cummins, returns to secular robust growth.
Profitability to surge from FY2012: KPIT has many margin levers in hand such as 1) expanding utilisation 2) rationalising employee pyramid and 3) taking up more of fixed price projects. We expect these levers to bolster the company’s EBITDA growth and margins to rebound to 17%, 18.3% and 18.4% for FY2011, FY2012 and FY2013, respectively, from 16% in 1HFY2011. Also with hedges turning into at-the-money, we expect it to aid the bottom line further, with a 20.2% CAGR over FY2010–13E, outperforming earnings growth of even tier-I IT companies.
Key valuation triggers: Management’s focus on 1) growth via inorganic strategy and proven track record of scaling up the acquired assets (such as Harita and CGS have grown at a 41%+ CAGR and Panex and SC have grown at a 18%+ CAGR since the time of their respective acquisition) and 2) monetisation of investments in Revolo by FY2013 by going-to-market may act as potential valuation triggers.
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