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Infotech Enterprises
3Q11 Results: First Signs of Price Increases with Large Clients
Quick Comment: Infotech reported its second
consecutive quarter of double-digit revenue growth
including the Wellsco acquisition. US$ revenues at
US$70m (up 10% qoq, 36% yoy) were ahead of our
expectations. The strong revenue growth has also
helped cushion the impact of lower than expected
operating margins. Overall, management expects
full-year net income of Rs1.4-1.45bn, in line with our
estimates. The implied net income for 4Q would be
Rs372-422m (+1% qoq to +15% qoq)
What's new: Reported revenues of Rs3138m (+6% qoq,
31% yoy) were ahead of our estimates. EBIT margins at
15.1% were lower than management guidance and our
expectations. Overall, net profit of Rs368m (+12% qoq,
-3% yoy) was ahead of our estimates. Despite two
quarters of double-digit revenue growth, Infotech stock
has not inched up. We believe lack of ability to protect
margins is hurting the stock’s performance and limiting
its multiples. We believe better pricing could help
margins recover in FY12e.
What we liked? 1) Continued revenue growth
momentum has been a positive surprise, in our view. 2)
Infotech has managed to get price increases with effect
from January 2011 from its top 3 clients to the extent of
3-5%, 3) Management sees scope to improve utilization
rates further to 80% in EMI and 85% in N&CE.
What we did not like? 1) Revenue growth from top 5
clients continues to lag the overall company average.
Top 5 clients have declined to 37% of revenues
(-800bps yoy) over the last one year. 2) SG&A expenses
increased by 15% qoq vs. management’s expectations
of flat qoq in absolute terms, impairing margins in 3Q. 3)
Rupee appreciation and pricing pressure with a large
client in the N&CE vertical also impaired Infotech’s
operating margins, though this was offset by improved
utilization rates.
Other Results Highlights
1) Capex was Rs59m in 3Q11 against the budgeted amount
of Rs302m. Management expects capex of Rs700-750m
in FY11e vs. the budgeted amount of Rs1170m.
2) Cash and cash equivalents were Rs3.8bn (US$85m),
~20% of current market cap.
3) DSO increased to 89 days (+4 qoq).
4) Attrition rates increased to 19% (+60bps qoq) on an
annualized basis
Conference Call Takeaways
1) Management believes that price increases of 3-5% with
top 3 clients would help revenue growth by 1.2%.
2) Expect engineering services clients (aerospace vertical)
budgets to increase in 2011. Management believes
revenue growth in EMI vertical (68% of revenues and
profits) could continue to grow ~8% qoq in the coming
quarters, implying 38-40% yoy growth in FY11e.
3) Management expects EBITDA margins to revert to the
18% level
Price Target: Our 12-month price target for Infotech is Rs203.
We apply a probability-weighted average to our risk-reward
scenarios to arrive at our price target (35%* bull case value of
Rs280 + 50%* base case value of Rs180 +15%* bear case
value of Rs100).
We use discounted cash flow methodology to arrive at our
risk-reward scenario values. Key assumptions include:
• FY11e-21e revenue CAGRs: Bull case 21.1%, base case
15.9%, bear case 11.5%.
• FY11e-21e EBIT CAGRs: Bull case 17.4%, base case
12.3%, bear case 7.7%.
• Exit EBIT margins in FY21e: Bull case 11.0%, base case
9.9%, bear case 8.6%.
We assume a cost of equity of 12.5% and a terminal growth
rate of 4%.
Valuation: On FY12e P/E, Infotech is trading at discount of
40-50% to large peers like TCS, Wipro, and HCLT. Infotech is
also trading at a discount to smaller peers on FY12e P/E. We
note that the stock trades at 12x one-year forward EPS, which
is below its one-year forward long-term average P/E of 13.5x.
Risks: 1) Delay in ramp-up of projects from clients in the UTG
(utilities, telecom, and government) segment. 2) Revenues
from large clients lag, dragging overall revenue growth. 3)
Pricing pressure from top clients could lead to margin pressure
over the coming quarters.4) Rupee appreciation vs.
US$ impacts margins; GBP and euro depreciation vs.
US$ hurts revenues
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