KPIT Cummins - Initiate coverage with a Buy rating and Target Price of `164

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Initiate coverage with a Buy rating and Target Price of `164

KPIT is riding high on the green shoots of recovery in its anchor vertical, i.e.
manufacturing, which is leading the company to post an 8.7% revenue CQGR over
2QFY2010–2QFY2011. We expect the growth momentum to continue as most of
KPIT’s manufacturing clients, including the top client Cummins, have returned to
their growth trajectories. Also, management is witnessing a strengthening demand
pipeline, which is leading the company to go in for aggressive hiring of 1,200 plus
net additions for FY2011 itself over the base of 4,352 employees at the beginning
of FY2011, implying annual growth of 28% in headcount. Hence, over FY2010–
13E, we expect KPIT’s revenue to grow at a scorching 24.9% CAGR (USD terms)
and 21.7% CAGR (INR terms); the CAGR in INR terms is lower because of stronger
rupee assumption.

KPIT has strong margin levers such as 1) expanding utilisation, which is currently
~68%, 2) rationaliasation of employee pyramid, which is currently skewed with
lateral:fresher ratio of 65:35 vis-à-vis IT peers with 55:45 ratio 3) expected pricing
uptick from FY2012 and 4) taking up of more fixed price projects, which is only
~30% of revenue. Thus, we expect the company’s EBITDA margin to bottom out in
FY2011 and then record strong EBITDA growth at a 23.3% CAGR over
FY2011–13E, ahead of the 18.5% revenue CAGR over the same period. Over
FY2010–13E, we expect PAT growth to outpace EBITDA growth (14.4% CAGR) at a
20.2% CAGR on the back of hedges turning into at-the-money going forward,
alleviating excessive forex losses and aiding profitability further.


Valuation

KPIT is better positioned in the mid-tier Indian IT space to capture growth in
spending related to discretionary services such as engineering and enterprise
solutions due to its strong domain focus. The company’s revenue growth and
profitability growth are expected to outpace that of its peers. Also, despite better
return ratios as compared to its mid-tier peers, the stock is currently trading at
cheap 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 a range of 6–17x. We Initiate Coverage on the stock with a Buy
recommendation, valuing the company at 9x FY2013E EPS (i.e. at ~55% discount
to Infosys’ implied FY2013 target P/E) with a Target Price of `164.