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KPIT CUMMINS
RECOMMENDATION: BUY
TARGET PRICE: RS.196
FY12E P/E: 11X
KPIT's PAT was marginally higher than our estimates. The consolidation of
financials of acquired companies increased revenues but one-off expenses
led to margin decline. Organic revenue growth of about 10% was largely
brought about by volumes, which is very encouraging. The 10% volume
growth is the highest among peers till date for December quarter.
Management commentary suggests decent visibility on revenues going
ahead. We opine that, the company is strategically well positioned with
focus verticals doing well. It has also made well - directed acquisitions,
which should help it penetrate clients and geographies. Strong additions to
the pipeline and additions to client acquisition resources should lead to
consistent revenue growth ahead.
Revolo is expected to be commercially launched in 1QFY12 and should add
to the growth in that fiscal. The company is already in talks with OEMs,
sales channels and corporates. The non-linear nature of revenues should
improve profitability, we believe. We have not yet accounted for these
revenues in our projections.
However, KPIT continues to be impacted by high attrition (30%+ on an
annual basis) and has been forced to spend additionally on recruitment and
training.
We make changes to our FY11 and FY12 earnings estimates in light of
improved demand conditions. Our earnings estimates stand at Rs.11.5
(Rs.12.3 earlier) and Rs. 14.4 (Rs.14.8) per share, respectively. We increase our
PT to Rs.196 (Rs.184), based on FY12E earnings, reflecting increased
optimism on business velocity. At our TP, the stock will be valued at about
13.5x FY12E earnings.
Belied hopes of volume-led-growth in IT services demand in major user
economies and a sharper-than-expected appreciation in rupee remain the
key risks for earnings. Revolo earnings can provide significant upsides, if
successful.
Revenues - up 10% QoQ organically; volumes also grow by 10%
n Revenues grew by 19% in USD terms. However, this was partly due to the consolidation
of financials of CPG and In2Soft WEF 3QFY11.
n On an organic basis, revenues grew by 10% QoQ, largely on the back of volumes.
n According to the management, volumes grew by about 10% QoQ, which was
better than expectations.
n In fact, volume growth is better than the growth rates reported by industry peers.
It looks particularly attractive when seen in the backdrop of an 8% growth reported
in 2Q.
n Average realizations were flat after successive improvements in the previous two
quarters. This rise in realizations was due to a change in mix in favour of higherend
businesses like auto embedded technologies, enterprise solutions and semiconductor
solutions.
n KPIT is also benefiting from a revival in demand in its focus verticals.
n The company has been able to win several orders.
n In the previous quarter, the company had won three large accounts aggregating
to about $40mn.
n The semiconductor business (SSG) saw a moderation in revenues largely due to
some project specific issues and seasonality, we believe.
n Here, KPIT has had wins in Europe & India during the quarter.
n It is now focusing on improving the volume of business for SSG customers, by
strengthening our front end team & account management process and also emphasizing
on new delivery models.
n The 10% rise in volumes is an improvement over the 8% growth in 2QFY11 and
indicates continuing traction in business.
n We believe that, the company should be able to achieve better growth rates and
the order book gets executed in future quarters.
n According to the management, the order pipeline has seen a significant rise,
especially in the Oracle business and in the automotive business.
n The growth in focus verticals indicates higher traction in those areas (ex-BFSI).
These verticals had witnessed extended decision making cycles for smaller payers
focused on verticals ex-BFSI, given the still challenging macro-environment.
n We note the manufacturing vertical contributes c78% of revenues; traction in
this vertical should auger well for the company going ahead.
n Industry peers have also indicated a revival in manufacturing and hi-tech / R&D.
n In addition, revenues from Cummins grew QoQ by 22%, the third successive
quarter of growth (7% QoQ in 2Q). This successive growth comes after a degrowth
in previous few quarters.
n According to the management, the worst may be over as far as the Cummins
account is concerned.
n We believe consistent and effective account management of non Cummins clients
is necessary for broad based revenue growth.
Employee strength up but so is the attrition
n The total employee strength of KPIT stood at 6229 (5953) as at the quarter end,
a net addition of 276 (609) employees.
n The management had indicated a target of adding 1100 - 1200 employees on a
net basis in FY11, which we believe, will be overshot. We have assumed net
addition of about 1400 billable employees in FY11.
n Capacity utilization was almost at the previous quarter levels. The company had
to recruit more to counter attrition and it also recruited more laterals.
n However, one negative was the continued high attrition at about 30% annualized.
n While mid-sized companies are facing higher attrition due to the buoyancy in the
industry and aggressive hiring by large companies, the attrition level for KPIT is
higher than peers.
n The management has indicated attrition may reduce in 4Q. However, we will
need to closely monitor this figure.
n The management is looking at replacing these with freshers and thus gaining
cost advantages. However, this can also impact the delivery and impact overall
productivity.
n KPIT had increased salaries by 12% on an average for off-shore employees and
by 2% for on-site employees in 1Q and the next increase is expected in 1QFY12.
EBITDA Margins- employee additions, integration expenses impact
profitability
n EBITDA margins in 2QFY11 fell by about 142bps on the back of rupee appreciation,
mix change in favour of lower margins projects ($1mn) and also some one
off expenses relating to acquisition of CPG and In2soft ($1mn).
n Going forward we expect margins to move higher in FY12 as utilization rates
improve and M&A expenses reduce.
n The company has disclosed that the total amount of hedges as on end 2QFY11
are $73mn ($85mn). Of these, hedges maturing in the next 3 months are
$13.1mn The company has disclosed that the average hedge rate for FY11 is
Rs.44.4/USD
Revolo - significant potential
n The plant near Hinjewadi, Pune is expected to be ready by 4QFY11 end.
n KPIT plans to launch the product on two products initially - 800cc and 3litre diesel
cars, we understand.
n KPIT's focus on moving up the value chain in focus verticals has led to the company
filing 27 patents till date and the development of Revolo.
n Revolo is a plug-in parallel hybrid solution which will allow the motor and engine
to work simultaneously.
n This has been developed in-house by KPIT and will be manufactured in a 50 : 50
JV with Bharat Forge.
n While KPIT will bring in its IP, Bharat Forge is expected to bring in its manufacturing
capabilities.
n The product has already been tested on various four-wheelers by Automotive
Regulatory Authority of India (ARAI).
n The company is already in talks with OEMs, corporates and sales channels for
sealing sales deals.
n The equity investments are expected to be Rs.1bn in the JV and commercial production
is expected to start byFY11 end.
n KPIT expects the JV's revenues to be Rs.3bn - Rs.5bn in the second year of operation,
based on an average realization of Rs.0.10mn per piece.
n We understand that, with an estimated pay-back period of about 2.5 - 3 years
for commercial operators and the focus on green technologies, the product has
the potential to be successful.
n We have not assumed any revenues from this JV in our estimates.
Change FY11 / FY12 estimates
n We have made marginal changes to account for the 3QFY11 results.
n We estimate FY11E and FY12E EPS of Rs.11.5 and Rs.14.4, respectively. FY12
earnings are on diluted equity post the preferential allotment to ChrysCapital.
Valuations and recommendation
n The stock is currently quoting at 11x FY12E earnings.
n We have accorded KPIT valuations higher than comparable peers, based on the
higher revenue growth and potential upsides to margins. At our target price,
KPIT's FY12E earnings will be discounted 13.4x.
n We maintain BUY with a revised PT of Rs.196 (Rs.184).
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
KPIT CUMMINS
RECOMMENDATION: BUY
TARGET PRICE: RS.196
FY12E P/E: 11X
KPIT's PAT was marginally higher than our estimates. The consolidation of
financials of acquired companies increased revenues but one-off expenses
led to margin decline. Organic revenue growth of about 10% was largely
brought about by volumes, which is very encouraging. The 10% volume
growth is the highest among peers till date for December quarter.
Management commentary suggests decent visibility on revenues going
ahead. We opine that, the company is strategically well positioned with
focus verticals doing well. It has also made well - directed acquisitions,
which should help it penetrate clients and geographies. Strong additions to
the pipeline and additions to client acquisition resources should lead to
consistent revenue growth ahead.
Revolo is expected to be commercially launched in 1QFY12 and should add
to the growth in that fiscal. The company is already in talks with OEMs,
sales channels and corporates. The non-linear nature of revenues should
improve profitability, we believe. We have not yet accounted for these
revenues in our projections.
However, KPIT continues to be impacted by high attrition (30%+ on an
annual basis) and has been forced to spend additionally on recruitment and
training.
We make changes to our FY11 and FY12 earnings estimates in light of
improved demand conditions. Our earnings estimates stand at Rs.11.5
(Rs.12.3 earlier) and Rs. 14.4 (Rs.14.8) per share, respectively. We increase our
PT to Rs.196 (Rs.184), based on FY12E earnings, reflecting increased
optimism on business velocity. At our TP, the stock will be valued at about
13.5x FY12E earnings.
Belied hopes of volume-led-growth in IT services demand in major user
economies and a sharper-than-expected appreciation in rupee remain the
key risks for earnings. Revolo earnings can provide significant upsides, if
successful.
Revenues - up 10% QoQ organically; volumes also grow by 10%
n Revenues grew by 19% in USD terms. However, this was partly due to the consolidation
of financials of CPG and In2Soft WEF 3QFY11.
n On an organic basis, revenues grew by 10% QoQ, largely on the back of volumes.
n According to the management, volumes grew by about 10% QoQ, which was
better than expectations.
n In fact, volume growth is better than the growth rates reported by industry peers.
It looks particularly attractive when seen in the backdrop of an 8% growth reported
in 2Q.
n Average realizations were flat after successive improvements in the previous two
quarters. This rise in realizations was due to a change in mix in favour of higherend
businesses like auto embedded technologies, enterprise solutions and semiconductor
solutions.
n KPIT is also benefiting from a revival in demand in its focus verticals.
n The company has been able to win several orders.
n In the previous quarter, the company had won three large accounts aggregating
to about $40mn.
n The semiconductor business (SSG) saw a moderation in revenues largely due to
some project specific issues and seasonality, we believe.
n Here, KPIT has had wins in Europe & India during the quarter.
n It is now focusing on improving the volume of business for SSG customers, by
strengthening our front end team & account management process and also emphasizing
on new delivery models.
n The 10% rise in volumes is an improvement over the 8% growth in 2QFY11 and
indicates continuing traction in business.
n We believe that, the company should be able to achieve better growth rates and
the order book gets executed in future quarters.
n According to the management, the order pipeline has seen a significant rise,
especially in the Oracle business and in the automotive business.
n The growth in focus verticals indicates higher traction in those areas (ex-BFSI).
These verticals had witnessed extended decision making cycles for smaller payers
focused on verticals ex-BFSI, given the still challenging macro-environment.
n We note the manufacturing vertical contributes c78% of revenues; traction in
this vertical should auger well for the company going ahead.
n Industry peers have also indicated a revival in manufacturing and hi-tech / R&D.
n In addition, revenues from Cummins grew QoQ by 22%, the third successive
quarter of growth (7% QoQ in 2Q). This successive growth comes after a degrowth
in previous few quarters.
n According to the management, the worst may be over as far as the Cummins
account is concerned.
n We believe consistent and effective account management of non Cummins clients
is necessary for broad based revenue growth.
Employee strength up but so is the attrition
n The total employee strength of KPIT stood at 6229 (5953) as at the quarter end,
a net addition of 276 (609) employees.
n The management had indicated a target of adding 1100 - 1200 employees on a
net basis in FY11, which we believe, will be overshot. We have assumed net
addition of about 1400 billable employees in FY11.
n Capacity utilization was almost at the previous quarter levels. The company had
to recruit more to counter attrition and it also recruited more laterals.
n However, one negative was the continued high attrition at about 30% annualized.
n While mid-sized companies are facing higher attrition due to the buoyancy in the
industry and aggressive hiring by large companies, the attrition level for KPIT is
higher than peers.
n The management has indicated attrition may reduce in 4Q. However, we will
need to closely monitor this figure.
n The management is looking at replacing these with freshers and thus gaining
cost advantages. However, this can also impact the delivery and impact overall
productivity.
n KPIT had increased salaries by 12% on an average for off-shore employees and
by 2% for on-site employees in 1Q and the next increase is expected in 1QFY12.
EBITDA Margins- employee additions, integration expenses impact
profitability
n EBITDA margins in 2QFY11 fell by about 142bps on the back of rupee appreciation,
mix change in favour of lower margins projects ($1mn) and also some one
off expenses relating to acquisition of CPG and In2soft ($1mn).
n Going forward we expect margins to move higher in FY12 as utilization rates
improve and M&A expenses reduce.
n The company has disclosed that the total amount of hedges as on end 2QFY11
are $73mn ($85mn). Of these, hedges maturing in the next 3 months are
$13.1mn The company has disclosed that the average hedge rate for FY11 is
Rs.44.4/USD
Revolo - significant potential
n The plant near Hinjewadi, Pune is expected to be ready by 4QFY11 end.
n KPIT plans to launch the product on two products initially - 800cc and 3litre diesel
cars, we understand.
n KPIT's focus on moving up the value chain in focus verticals has led to the company
filing 27 patents till date and the development of Revolo.
n Revolo is a plug-in parallel hybrid solution which will allow the motor and engine
to work simultaneously.
n This has been developed in-house by KPIT and will be manufactured in a 50 : 50
JV with Bharat Forge.
n While KPIT will bring in its IP, Bharat Forge is expected to bring in its manufacturing
capabilities.
n The product has already been tested on various four-wheelers by Automotive
Regulatory Authority of India (ARAI).
n The company is already in talks with OEMs, corporates and sales channels for
sealing sales deals.
n The equity investments are expected to be Rs.1bn in the JV and commercial production
is expected to start byFY11 end.
n KPIT expects the JV's revenues to be Rs.3bn - Rs.5bn in the second year of operation,
based on an average realization of Rs.0.10mn per piece.
n We understand that, with an estimated pay-back period of about 2.5 - 3 years
for commercial operators and the focus on green technologies, the product has
the potential to be successful.
n We have not assumed any revenues from this JV in our estimates.
Change FY11 / FY12 estimates
n We have made marginal changes to account for the 3QFY11 results.
n We estimate FY11E and FY12E EPS of Rs.11.5 and Rs.14.4, respectively. FY12
earnings are on diluted equity post the preferential allotment to ChrysCapital.
Valuations and recommendation
n The stock is currently quoting at 11x FY12E earnings.
n We have accorded KPIT valuations higher than comparable peers, based on the
higher revenue growth and potential upsides to margins. At our target price,
KPIT's FY12E earnings will be discounted 13.4x.
n We maintain BUY with a revised PT of Rs.196 (Rs.184).
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