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NIIT TECHNOLOGIES LTD (NIITT)
PRICE: RS.210
RECOMMENDATION: BUY
TARGET PRICE: RS.311
FY10E P/E: 5.9X
NIITT's 3QFY11 results soundly beat our estimates. Revenues grew by 5%
(excluding BSF order), on the back of a 4.7% rise in volumes, which was a
positive surprise in a seasonally weak quarter. Average realizations
remained stable. The company was able to maintain the EBIDTA margins (exBSF) despite some increase in off-shore salaries. Non-linear revenues and offshore shift helped. Acquisition of a healthcare platform is a step further in
the direction of non-linear revenues. ROOM revenues are also showing
consistent growth. Non-linear revenues grew at company average and did
provide some support to margins. The order bookings have maintained
momentum with the company bidding for a few larger orders in the $10mn
- $50mn range. We have increased our FY11E and FY12E EPS estimates to
Rs.31 and Rs.34.8. Our DCF - based price target stands at Rs.311 (Rs.291
earlier), based on FY12 earnings. At our TP, our FY12 earnings will be
discounted by about 9x which, we believe, is undemanding. We maintain
BUY. NIITT has been achieving consisting revenue growth and margins over
the past few quarters. We note that, 4Q revenues may see moderate growth
in line with the reduction in BSF bought-out component.
Revenues grow by 5% QoQ (excluding bought-outs for BSF
deal)….
n Revenues grew by 5% on a sequential basis, excluding the bought-outs for the
BFS deal.
n During 1QFY11, NIITT had started executing the BSF project. The initial phase
involves building the infrastructure and the same was partially carried out during
9mFY11.
n The revenues of 3QFY11 include about Rs.148mn (Rs.537mn) of bought out components towards this.
…led by 4.7% volume growth
n Revenues also include forex loss on hedging of Rs.51mn as against a loss of
Rs.96mn in the previous quarter.
n Excluding these, revenues were higher by about 4% QoQ, which was a pleasant
surprise.
n According to the management, volumes grew by about 4.7% QoQ. Currency
fluctuations impacted growth rates during the quarter whereas average realizations were marginally changed.
n The 4.7% growth is encouraging and would in all probability by in line with the
growth rates of larger peers.
Broad-based growth
n What is more encouraging is that the revenue growth was experienced across
clients, geographies, verticals.
n All the geographies grew in INR terms with APAC bringing in 14% QoQ rise.
n The management indicated greater traction in APAC region because of the
faster economic recovery in this region.
n Among verticals, Travel & Transportation grew by 9% QoQ.
n BFSI grew by 3% QoQ. The company experienced strong recovery with US clients and also added a significant new customer in Insurance.
n ROOM Solutions, which has now been named NIIT Insurance Technologies Ltd,
saw revenue of Rs.306mn with stand-alone margins at 25% (26%).
n ROOM's margins have been maintained at elevated levels after expanding significantly over the past two quarters in line with higher revenues and the non-linear nature of these revenues.
n Manufacturing saw revenues fall by 5% QoQ. The vertical has been the last to
recover and is yet to see large deal flows.
n 2 new customers were added during the quarter.
Macro scene improving
n The company has witnessed an overall improvement in the macro scene, especially in USA and in India.
n The overall spending on IT is on the rise, buoyed by the release of pent-up demand of the past few quarters.
n The off-shore component in budgets has increased and this move towards offshoring is helping Indian vendors who are receiving larger order-flows.
n BFSI and Travel & Transportation (T&T) verticals have seen further improvement
in demand. The retail vertical has also seen traction.
n BFSI is seeing continued spends towards regulatory compliance and also discretionary spend.
n Within T&T, the airlines vertical has seen a re-emergence of spending. According
to the management, as compared to a combined loss of about $10bn in
CY2009, IATA expects airlines to rake in profits of about $16.1bn in CY2011.
n Passenger traffic is expected to rise by 8.9% and cargo traffic by 18.5%
n For Manufacturing and Distribution, the focus is still on supply chain and customers but significant deal flows are yet to start.
Non-linear initiatives
n Non-linear initiatives has continued to scale in the current quarter.
n Non-linear initiatives formed 27% of overall revenues in 3QFY11 v/s 27% QoQ
and we expect them to continue to form about 27% of overall revenues in the
near term.
n However, the contribution is expected to increase as the business gains greater
scale.
n NIIT's non-linear services can broadly be divided into three parts - managed services (13% of revenues), platforms and related solutions (14% of revenues) and
cloud services.
n The company has various platforms for the insurance vertical - Subscribe
(ROOM), airlines vertical (revenue accounting) and cargo business (through partners).
n The platform based services should gather steam in the future quarters (with
ROOM's platform gaining traction) while the IMS business is expected to contribute for the whole fiscal.
n ROOM's revenues have scaled up during the quarter. ROOM is more into the
non-life market, which had not been impacted significantly.
n The company has plans of introducing ROOM's platform to the US markets. This
is expected to be done by implementing the PF at the Bermuda location of an
existing European client.
n We expect the entry into US to be slow because of the need to incorporate
changes required by different regulations.
n The company has also launched the SaaS initiative and the Cloud initiative recently. Initially, it had planned to offer only infrastructure outsourcing services.
n It has announced a partnership with Hitachi Information Systems, Ltd., Japan
FY10 to offer Cloud services.
n The partnership is currently working on 3 pilot projects, which may scale up in
future quarters.
n Initially, non-critical applications like HR, Payroll, etc will be offered by NIITT on
Cloud.
n The company has also executed two projects wherein it has offered Testing as a
service.
Foray into Healthcare through cloud - based platform
n During the quarter the Company acquired a cloud based referral management
platform to initiate its foray into the lucrative healthcare segment in the US.
n The platform called "Preferr" (Patient Referral System)" enables seamless collaboration between all providers namely physicians, hospitals, diagnostic facilities, and laboratories.
n The platform enables providers to meet federal guidelines for Electronics Health
Record meaningful use criteria.
n This will be offered to clients on a SAS basis, thereby adding to non-linear revenues. About 300 doctors are already using this PF, we believe.
n These non-linear initiatives are expected to help the company restrict impact on
margins due to salary hikes and potential rupee appreciation, if any
BSF order - implementation revenues have started to accrue,
bought-outs reduced
n The company announced an order from BSF (Border Security Force) worth
Rs.2.28bn in 4QFY10, to be implemented over a five year period. The order involves the entire gamut of operations including troop movement, payrolls, accounting, etc.
n This SI order also includes a hardware component which, we believe, is about
Rs.1.2bn.
n The order started in 1QFY11 and the company has already supplied hardware of
about Rs.1.15bn till 3Q.
n The implementation revenues have started accruing and further revenues are
expected to accrue going forward.
n According to the management, the bought-out component is expected to reduce
in 4QFY11 to Rs.100mn (Rs.148mn in 3Q)
High addition to employees; attrition remains high; salary hikes
given
n Attrition remained high at about 18.4% during the quarter (18.6% QoQ).
n NIITT added 364 employees on a net basis during the quarter. This follows the
highest net addition done by the company during the previous quarter.
n We believe that, attrition will remain high because of the general buoyancy in
the sector and aggressive hiring / salary increments by larger peers.
n At 84%, the company also does not have the liberty to expand the utilization
levels further.
n During the quarter, company gave salary hikes of about 5% average to off-shore
employees and plans to give further hikes for specific skills in 4Q.
n The 9% annual average hike had been divided equally between 1QFY11 and
3QFY11.
n On-site employees were given an average hike of 2% - 3% WEF 2QFY11.
Margins maintained
n EBIDTA margins excluding the bought-outs, were maintained at about 21.6%,
despite the salary increment given to off-shore employees and the rupee appreciation.
n We understand that, higher off-shore component (43% v/s 41%), better leverage
on costs and higher revenues helped company sustain margins.
n Non-linear revenues formed 27% of the quarter revenues and also helped in restricting impact on margins.
Exchange rate movement
n NIITT had forex loss of about Rs.9mn (loss of Rs.23mn) during the quarter, largely
due to translation losses.
n The company has $34.5mn ($46mn) of hedges at an average of about Rs.43.4 /
USD.
Future prospects
n We tweak our earnings estimates. We have assumed the rupee to be at Rs.45
per USD in 2HFY11.
n For FY11, we expect USD revenues (ex bought-outs) to grow by 26% on the
back of a 27% rise in volumes. The expected rupee appreciation may impact
overall revenue growth.
n EBIDTA margins are expected to be marginally lower as against FY10 levels because of the bought - outs, exchange rate and the expected salary increments in
FY11.
n Net profit is expected to be Rs.1.84bn in FY11, translating into earnings of
Rs.31.2 in FY11.
n For FY12, we expect volumes to grow by 24%. We need to watch out for the
evolving macro scenario in the developed economies.
n We have assumed the rupee to average 45 / USD in FY12.
n EBIDTA margins are expected to be higher due to higher non-linear revenues
and absence of bought outs.
n We have increased the tax rate to 25% of PBT as STPI unit benefits are expected
to expire WEF FY12.
n Consequently, PAT is expected to rise by 12% to Rs.2.05bn, translating into EPS
of Rs.35.
Valuations and recommendation
n In our DCF model, we have incorporated a benign operating environment in our
near term assumptions for the company.
n A WACC of 15% and terminal growth of 2% leads us to a fair value of Rs.311
for the stock, based on FY12 estimates.
n At those levels the stock will quote at about 9x FY12 earnings, which is reasonable, in our view.
n We maintain a BUY.
n The company may have net cash of about Rs.67 per share by FY12 end, as per
our estimates.
Concerns
n Rupee appreciation beyond our assumed levels could provide a downward bias
to our earnings estimates.
n A delayed recovery in major global economies could impact growth prospects of
NIITT.
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