Infotech Enterprises – 3QFY2011 Result Update- Angel Broking

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Infotech Enterprises – 3QFY2011 Result Update

Angel Broking recommend an Accumulate on Infotech Enterprises with a Target Price of Rs190

For 3QFY2011, Infotech Enterprises (IEL) posted a mixed performance. The

company outperformed our revenue expectation but disappointed on the

operating front. The key highlight of the result was that IEL managed to garner

the increase in offshore price points by 3–5% across its top three clients i.e.,

United Technology, Tom Tom and Bombardier. Amongst them, one of the clients

also gave a price increase of 2% onsite. Going forward, IEL plans to hire 500

freshers and have close to 600 open billable positions likely to be filled by

laterals. We expect IEL to post a 24% CAGR in revenue on the back of organic as

well as inorganic growth (i.e. Daxcon and Wellsco integration). Valuing the

company at 12x FY2012E EPS of `15.8, we recommend Accumulate.

Quarterly highlights: During 3QFY2011, revenue grew by 10.1% qoq to

US $69.9mn due to strong volume growth of 14.1% in NCE (incl. Wellsco offering

6.5% organic growth) and 5.2% in ENGG. However, margins lacked luster and

dipped by 10bp (v/s our expectation of 110bp expansion) to 15.1% due to

a) stronger INR b) investments in S&M and c) the full integration effect of Wellsco

(with margins lower at ~6.3%).

Outlook and valuation: Management is confident of an 8% CQGR in volume in

ENGG to sustain and NCE to grow non-linearly. IEL is witnessing strong demand

for ENGG from 1) aerospace, 2) hi-tech and 3) heavy engineering (except rail,

which is still a laggard) segments. In case of NCE, IEL foresees demand building

up in the telecom and utilities segments. Over FY2010–12, we expect IEL’s USD

revenue to post a 28% CAGR and EBITDA margins to expand to 17.3% due to

levers such as a) utilisations and productivity b) pricing increase and c) effort

management. Thus, we recommend Accumulate with a Target Price of `190.

Volume growth momentum continues to drive revenue

For 3QFY2011, IEL reported 10.1% qoq growth in revenue (USD terms), backed

by strong volume growth of 14.1% and 5.2% qoq in the network and content

engineering (NCE) and engineering manufacturing and industrial products

(ENGG) segments, respectively. IEL reported consolidated volume growth of 7.9%

qoq. Growth momentum in the ENGG vertical continued during the quarter,

whereas the NCE vertical posted stupendous growth because of volume growth of

7.6% due to Wellsco’s acquisition, which further aided organic volume growth of

6.5%. In USD terms, revenue grew by 10.1% qoq to US $69.9mn (US $63.5mn in

2QFY2011). In INR terms, revenue growth came in lower at 6.2% due to a 1.7%

negative impact of INR appreciation against USD in 3QFY2011.

NCE: IEL rebranded its utilities, telecom and government (UTG) vertical to the NCE

vertical during the quarter. The NCE segment’s revenue grew by 17.3% qoq to

US $22.8mn in 3QFY2011. Maximum growth in the segment came in from the US

and APAC region.

Industry wise, it was a good quarter for telecom, with higher contributions from

AT&T, Verizon and Telstra. Operating margins improved slightly due to better

gross margins from APAC operations and significant qoq improvement in

utilisations to 81% from 75%.

ENGG: The ENGG vertical grew by 7.1% qoq to US $47.2mn on the back of

strong demand and strong utilisations of 75% (v/s 73% in 2QFY2011). Also, the

company’s top clients, Bombardier and United Technology have passed on the

offshore price hike to the company, effective January 2011, which will be reflected

from 4QFY2011. In addition, the company signed MSAs with Textron and Energy

Solutions and added eight new clients during the quarter.

Margin disappoints

In 3QFY2011, IEL recorded a 10bp qoq dip in EBITDA margins to 15.1% on the

back of 1) stronger INR 2) full effect of Wellsco integration (with EBITDA margins of

~6.3%) and 3) investments in S&M taking away gains due to strong volume

growth and utilisations.

Hiring in ENGG continues

IEL continues to hire in its ENGG vertical. In 3QFY2011, the company added 353

people on the base of 3,706 people to map the buoyant demand witnessed in this

vertical. In case of NCE, the employee base reduced by 176, as the company is

rationalising the segment with the integration of Wellsco and expects more

non-linearity in revenue going forward. In addition, the company is hiring people

in support to tap the opportunities emerging by strengthening its sales team.

Outlook and valuation

Management is confident of recording an 8% CQGR in volumes in its anchor

vertical, ENGG (67.5% to revenue), on the back of a strengthening demand

landscape in the aerospace (57% to revenue); hi-tech (11% to revenue); and heavy

engineering–except rail, which is still a laggard (10% to revenue) segments. In fact,

IEL hinted that one of its ENGG customers is looking at increasing its annual

budget by 15% yoy. Also, price increases of 3–5% by top clients, Bombardier and

United Technology, envisage on the increasing demand for engineering services,

with their business returning back to normalcy. The NCE vertical has also attained

stability and is recording strong organic growth of 6.5% CQGR since the past two

quarters. Management is witnessing demand for its GIS services by the telecom

and the utilities vertical, which comprises 67% of its NCE revenue. Also, in its

content business (one-third of NCE revenue), the company managed to renew

contract with its second largest client Tom Tom.

Thus, we expect growth momentum to continue and record a revenue CAGR of

28% over FY2010–12E on the back of organic as well as inorganic segments.

Further, we expect profitability to rebound and EBITDA margins to scale back to

17.3% by FY2012 (from YTDFY2011 of 15.5%) on the back of levers such as

a) utilisations and productivity b) pricing increase and c) effort management.

We value the company at 12x FY2012E EPS of `15.8 i.e., at 52% discount to

Infosys. We recommend Accumulate on the stock with a Target Price of `190.