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Allied Digital (ALDS) continued to disappoint for the second consecutive quarter
in Q3FY11 with the solutions business being a drag.
Top line takes a beating
ALDS’ topline was lackluster down 10.8%QoQ to Rs1.74bn, owing to 20%QoQ decline in the
solutions segment, due to the planned strategy to de-focus on low margin. EBITDA margin
decline by 570bps QoQ to 15.5% is significant which includes a one-time bad debt provision
of Rs75mn, excluding which the margin decline is 140bps to 19.8%. PAT de-growth of
33%QoQ to Rs198mn, is way below our expectations.
Order book takes a takes a hit; Pipeline improving
In line with the company’s conscious decision to move away from the low-margin solutions
business, order book declined 11.6% to Rs5.2bn, due to 18%QoQ decline in solutions order
book. Although services order book dipped 9%QoQ due to shift from low-margin services,
the current deal pipeline is looking healthy with incremental revenue expected to kick in
from Q4FY11.
Decline in Capital output ratio to ease out gradually
Investments in capex over the past 3 yrs have not yielded commensurate growth, as visible
in the capital output ratio, which dropped significantly from 18 to 3 over FY08-10.
Consequently, the stock’s valuation has taken a beating. The sharp fall in this ratio is a
concern, although more of it is attributed to migration delays. However, we expect
improvement in this trend with acceleration in revenue growth and lower capex in FY12.
Compelling valuations
We expect ALDS to benefit from the ongoing restructuring efforts to trim old low-margin
contracts in FY12. While the execution needs to be closely watched out, we expect
incremental revenues to accrue in Q4FY11. With a substantial 53% drop in the stock in just
one week, valuations are quite cheap at 2.5x FY12E earnings (65% discount to past two-year
avg of 7.7x), indicating limited downside. However, we do not see any sharp reversal in
valuations before the management delivers robust quarterly numbers and investor
confidence returns. At CMP, we are positive purely from a valuation perspective, and rate
the stock as Accumulate with a target of Rs109 (3.5x FY12).
Order flow seems healthy
The deal pipeline (in the services segment) is strong for ALDS. The 4-5 multi-year deals of USD1-5mn per
annum bagged in Q2FY11 are expected to begin contributing to revenue from Q4FY11. The major ones are
the five-year multi-million dollar deal with a global public transportation company, one with a global law
firm with 18 locations and another with a hotel chain for complete IT infrastructure management.
Efforts to restore investor confidence
In the wake of recent dip in stock price and declining investor confidence, the management is in a firefighting
mode. The following immediate steps have been taken:
A reputed, joint auditor has been appointed in addition to the existing one (Kapadia and associates).
A board meeting is scheduled on 18 February 2011 to consider a buyback.
Something to cheer about at current valuations
Revenues from the 3-4 deals worth USD1-5mn p.a. secured in the previous quarter will kick in Q4FY11
onwards.
The inability to deliver adequate revenue growth over the past 2 quarters has been driven more by
strategic shift and delays such as migration issues around Win7 (not attributed to ALDS), leading to
delays in the Lenovo deal. However, we note the management’s inability to grow the business of the
acquired entity, EPGS.
The company has pre-empted growth much in advance and accelerated its capex, with revenue
accretion to happen only steadily. Capex to reduce significantly in FY12 from Rs1.2bn (FY11E) to Rs
0.35-0.4bn. Declining trend in capital-output ratio to reverse in FY12.
Valuations at dirt cheap levels 2.5x FY12 earnings, thereby limiting any significant downside. We value
the stock at 3.5x FY12 earnings, which is still significant discount to most other midcap IT companies.
Significant shift to services business to boost margins
With the services pipeline looking strong, we expect the business’ contribution to increase substantially.
Reducing focus on pure hardware solutions will also enable share of the services business to increase and
that of solutions would decline. We expect the services-solutions mix to reach 68:32 by end-FY12 from the
current 60:40.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Allied Digital (ALDS) continued to disappoint for the second consecutive quarter
in Q3FY11 with the solutions business being a drag.
Top line takes a beating
ALDS’ topline was lackluster down 10.8%QoQ to Rs1.74bn, owing to 20%QoQ decline in the
solutions segment, due to the planned strategy to de-focus on low margin. EBITDA margin
decline by 570bps QoQ to 15.5% is significant which includes a one-time bad debt provision
of Rs75mn, excluding which the margin decline is 140bps to 19.8%. PAT de-growth of
33%QoQ to Rs198mn, is way below our expectations.
Order book takes a takes a hit; Pipeline improving
In line with the company’s conscious decision to move away from the low-margin solutions
business, order book declined 11.6% to Rs5.2bn, due to 18%QoQ decline in solutions order
book. Although services order book dipped 9%QoQ due to shift from low-margin services,
the current deal pipeline is looking healthy with incremental revenue expected to kick in
from Q4FY11.
Decline in Capital output ratio to ease out gradually
Investments in capex over the past 3 yrs have not yielded commensurate growth, as visible
in the capital output ratio, which dropped significantly from 18 to 3 over FY08-10.
Consequently, the stock’s valuation has taken a beating. The sharp fall in this ratio is a
concern, although more of it is attributed to migration delays. However, we expect
improvement in this trend with acceleration in revenue growth and lower capex in FY12.
Compelling valuations
We expect ALDS to benefit from the ongoing restructuring efforts to trim old low-margin
contracts in FY12. While the execution needs to be closely watched out, we expect
incremental revenues to accrue in Q4FY11. With a substantial 53% drop in the stock in just
one week, valuations are quite cheap at 2.5x FY12E earnings (65% discount to past two-year
avg of 7.7x), indicating limited downside. However, we do not see any sharp reversal in
valuations before the management delivers robust quarterly numbers and investor
confidence returns. At CMP, we are positive purely from a valuation perspective, and rate
the stock as Accumulate with a target of Rs109 (3.5x FY12).
Order flow seems healthy
The deal pipeline (in the services segment) is strong for ALDS. The 4-5 multi-year deals of USD1-5mn per
annum bagged in Q2FY11 are expected to begin contributing to revenue from Q4FY11. The major ones are
the five-year multi-million dollar deal with a global public transportation company, one with a global law
firm with 18 locations and another with a hotel chain for complete IT infrastructure management.
Efforts to restore investor confidence
In the wake of recent dip in stock price and declining investor confidence, the management is in a firefighting
mode. The following immediate steps have been taken:
A reputed, joint auditor has been appointed in addition to the existing one (Kapadia and associates).
A board meeting is scheduled on 18 February 2011 to consider a buyback.
Something to cheer about at current valuations
Revenues from the 3-4 deals worth USD1-5mn p.a. secured in the previous quarter will kick in Q4FY11
onwards.
The inability to deliver adequate revenue growth over the past 2 quarters has been driven more by
strategic shift and delays such as migration issues around Win7 (not attributed to ALDS), leading to
delays in the Lenovo deal. However, we note the management’s inability to grow the business of the
acquired entity, EPGS.
The company has pre-empted growth much in advance and accelerated its capex, with revenue
accretion to happen only steadily. Capex to reduce significantly in FY12 from Rs1.2bn (FY11E) to Rs
0.35-0.4bn. Declining trend in capital-output ratio to reverse in FY12.
Valuations at dirt cheap levels 2.5x FY12 earnings, thereby limiting any significant downside. We value
the stock at 3.5x FY12 earnings, which is still significant discount to most other midcap IT companies.
Significant shift to services business to boost margins
With the services pipeline looking strong, we expect the business’ contribution to increase substantially.
Reducing focus on pure hardware solutions will also enable share of the services business to increase and
that of solutions would decline. We expect the services-solutions mix to reach 68:32 by end-FY12 from the
current 60:40.
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