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Syntel, Inc.
Neutral ; SYNT, SYNT US
F4Q Post View - CY11 Guidance Looks Conservative, Tweaking Estimates
SYNT reported modest 4Q results and issued CY11 guidance that, at its high end,
was about in line with estimates. However, we are not overly concerned with the
annual guidance given the company’s track record of issuing very conservative
guidance at this stage (see Table 1 below). The company indicated offshore
demand environment remains strong, which, coupled with relatively modest
expectations, could drive stock outperformance in CY11. The company also faces
grow-over risks in C1Q which it believes will result in flat q/q growth in the
quarter. However, we expect normalized growth rates should resume from C2Q,
in line w/ the seasonal patterns. We are more constructive on the SYNT stock but
remain Neutral due to its high customer concentration (top 3 contributed 50% of
revenue in 4Q).
• 4Q10 operating miss. Revenues/EPS of $145M/$0.71 compared with JPMe
of $148M/$0.68 and consensus of $147M/$0.68. Revenue increased 23% Y/Y
and 3% Q/Q. SYNT’s 4Q revenue growth (q/q) was below expectations and at
the low end of the rates reported by many large cap offshore IT services firms.
SYNT attributed the 4Q miss to ramp-down in its two contracts, which will
continue to hurt its 1Q11 revenue growth. Relative to our model, $0.04 in
operating miss (due to lower revenue and margins) was more than offset by
$0.03 in higher other income and $0.04 in lower taxes.
• Mixed growth trends. SYNT’s core IT services business (apps outsourcing +
ebiz) increased 4% q/q during the quarter, driven by 8% growth in the
discretionary ebiz segment. KPO revenue declined 1% q/q. The company’s top
10 customers grew by an above-average 3.5% q/q rate in 4Q, and the company
indicated clients# 11-30 also grew at a healthy rate and should grow faster in
2011.
• CY11 guidance looks conservative. SYNT issued FY11 revenue/EPS
guidance of $600-630M/$2.65-2.90 compared to prior JPMe of $656M/$2.95
and consensus of $634M/$2.94. The guidance range, coming in below
estimates, is not surprising to us and should prove conservative – consistent
with SYNT’s preference for raising its annual guidance through out the year.
Moreover, we believe the EPS guidance is likely more conservative than the
revenue guide, as any potential revenue upside should come at high
incremental margins (the company has ample headcount and facility capacity
to service higher growth).
• Margins hurt by weak gross margins. 4Q operating margin of 20.9% was
below our estimate of 21.7% and 3Q margin of 21.9%, and was impacted by
gross margin deterioration (38.4% vs. 39.6% in 3Q and our estimate of 39.8%).
The company attributed the sequential margin decline to rupee appreciation (70-
bp impact on gross margin) and lower utilization (blended utilization declined
300bps q/q). The company expects its employee utilization rate to increase in
CY11.
• Adjusting estimates. Our 2011 and 2012 revenue/EPS estimates go from
$656M/$2.95 and $775M/$3.47 to $638M/$2.91 and $759M/$3.46, respectively.
Our new CY11 estimates represent 20% revenue growth and 22.4% operating
margin. While a potential appreciation in the Indian rupee (vs. the USD) could
adversely impact the company's CY11 margins, we believe SYNT possesses
enough levers, such as below-industry-average utilization rate (specifically in its
IT services business) and ahead-of-curve investments in facilities, to partially
offset margin headwinds.
Valuation
Price Target Methodology
Emphasizing the E over the Multiple
Our price target methodology emphasizes our CY12 EPS estimate as the primary
driver of our relative valuation analysis, as the bulk of our coverage stocks are valued
on P/E. NTM P/E multiples have been volatile in recent months. We acknowledge
the difficulty in pinpointing the multiple in such volatile times, which is why we are
prioritizing “getting the E right,” while being conservatively prudent in selecting a
multiple based on historical and relative valuation measures. We also consider other
implied valuation metrics to support our target to account for variances in business
models and differences in sensitivity to cyclical, competitive and secular changes.
Specifically, we also consider EV/EBITDA and FCF yields when assessing
valuation.
• Our latest view on CAGR in EPS from 2010-2013E and implied PEG. To
arrive at our price target, we consider our 2010-2013E CAGR in EPS, and
generally assume a PEG of about 1.2x for the IT Services group, but adjust for
company-specific factors for each stock.
• Staying within historical multiple ranges. Given uncertainty in the macro, our
target multiple tries to stay within recent multiple ranges since 2008.
• Rolling CY11 P/E. Our implied target multiple (on CY12E EPS) generally does
not imply any material change from the P/E multiple calculated against our
CY11E EPS. Any difference in our target multiple from the current multiple can
generally be explained by our view that a premium or discount is warranted given
where the stock has traded historically relative to its peers or other factors like
changes in leverage, FX, client risk, or particulars in the specific end market that
drive company-specific growth/margins.
Price Target
Our SYNT price target of $66 applies a 19x multiple to our CY12E EPS of $3.46.
SYNT is currently trading at 19x our CY11E EPS, while peers are also trading at
19x. Over the last year, SYNT has traded at a -2% discount relative to its peers on
NTM P/E. We estimate SYNT earnings will grow 13.7% over the next three years
(2009-12E), and our price target implies a 38.3% premium to the earnings CAGR.
Investment Risks
We see the following key risks to our Neutral rating:
• A deteriorating IT services spending environment or an appreciation in Indian
rupee.
• Loss of a large customer, as SYNT's top 10 customers account for 70%+ of
revenue.
• Faster-than-expected ramp in high margin KPO business may drive outperformance.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Syntel, Inc.
Neutral ; SYNT, SYNT US
F4Q Post View - CY11 Guidance Looks Conservative, Tweaking Estimates
SYNT reported modest 4Q results and issued CY11 guidance that, at its high end,
was about in line with estimates. However, we are not overly concerned with the
annual guidance given the company’s track record of issuing very conservative
guidance at this stage (see Table 1 below). The company indicated offshore
demand environment remains strong, which, coupled with relatively modest
expectations, could drive stock outperformance in CY11. The company also faces
grow-over risks in C1Q which it believes will result in flat q/q growth in the
quarter. However, we expect normalized growth rates should resume from C2Q,
in line w/ the seasonal patterns. We are more constructive on the SYNT stock but
remain Neutral due to its high customer concentration (top 3 contributed 50% of
revenue in 4Q).
• 4Q10 operating miss. Revenues/EPS of $145M/$0.71 compared with JPMe
of $148M/$0.68 and consensus of $147M/$0.68. Revenue increased 23% Y/Y
and 3% Q/Q. SYNT’s 4Q revenue growth (q/q) was below expectations and at
the low end of the rates reported by many large cap offshore IT services firms.
SYNT attributed the 4Q miss to ramp-down in its two contracts, which will
continue to hurt its 1Q11 revenue growth. Relative to our model, $0.04 in
operating miss (due to lower revenue and margins) was more than offset by
$0.03 in higher other income and $0.04 in lower taxes.
• Mixed growth trends. SYNT’s core IT services business (apps outsourcing +
ebiz) increased 4% q/q during the quarter, driven by 8% growth in the
discretionary ebiz segment. KPO revenue declined 1% q/q. The company’s top
10 customers grew by an above-average 3.5% q/q rate in 4Q, and the company
indicated clients# 11-30 also grew at a healthy rate and should grow faster in
2011.
• CY11 guidance looks conservative. SYNT issued FY11 revenue/EPS
guidance of $600-630M/$2.65-2.90 compared to prior JPMe of $656M/$2.95
and consensus of $634M/$2.94. The guidance range, coming in below
estimates, is not surprising to us and should prove conservative – consistent
with SYNT’s preference for raising its annual guidance through out the year.
Moreover, we believe the EPS guidance is likely more conservative than the
revenue guide, as any potential revenue upside should come at high
incremental margins (the company has ample headcount and facility capacity
to service higher growth).
• Margins hurt by weak gross margins. 4Q operating margin of 20.9% was
below our estimate of 21.7% and 3Q margin of 21.9%, and was impacted by
gross margin deterioration (38.4% vs. 39.6% in 3Q and our estimate of 39.8%).
The company attributed the sequential margin decline to rupee appreciation (70-
bp impact on gross margin) and lower utilization (blended utilization declined
300bps q/q). The company expects its employee utilization rate to increase in
CY11.
• Adjusting estimates. Our 2011 and 2012 revenue/EPS estimates go from
$656M/$2.95 and $775M/$3.47 to $638M/$2.91 and $759M/$3.46, respectively.
Our new CY11 estimates represent 20% revenue growth and 22.4% operating
margin. While a potential appreciation in the Indian rupee (vs. the USD) could
adversely impact the company's CY11 margins, we believe SYNT possesses
enough levers, such as below-industry-average utilization rate (specifically in its
IT services business) and ahead-of-curve investments in facilities, to partially
offset margin headwinds.
Valuation
Price Target Methodology
Emphasizing the E over the Multiple
Our price target methodology emphasizes our CY12 EPS estimate as the primary
driver of our relative valuation analysis, as the bulk of our coverage stocks are valued
on P/E. NTM P/E multiples have been volatile in recent months. We acknowledge
the difficulty in pinpointing the multiple in such volatile times, which is why we are
prioritizing “getting the E right,” while being conservatively prudent in selecting a
multiple based on historical and relative valuation measures. We also consider other
implied valuation metrics to support our target to account for variances in business
models and differences in sensitivity to cyclical, competitive and secular changes.
Specifically, we also consider EV/EBITDA and FCF yields when assessing
valuation.
• Our latest view on CAGR in EPS from 2010-2013E and implied PEG. To
arrive at our price target, we consider our 2010-2013E CAGR in EPS, and
generally assume a PEG of about 1.2x for the IT Services group, but adjust for
company-specific factors for each stock.
• Staying within historical multiple ranges. Given uncertainty in the macro, our
target multiple tries to stay within recent multiple ranges since 2008.
• Rolling CY11 P/E. Our implied target multiple (on CY12E EPS) generally does
not imply any material change from the P/E multiple calculated against our
CY11E EPS. Any difference in our target multiple from the current multiple can
generally be explained by our view that a premium or discount is warranted given
where the stock has traded historically relative to its peers or other factors like
changes in leverage, FX, client risk, or particulars in the specific end market that
drive company-specific growth/margins.
Price Target
Our SYNT price target of $66 applies a 19x multiple to our CY12E EPS of $3.46.
SYNT is currently trading at 19x our CY11E EPS, while peers are also trading at
19x. Over the last year, SYNT has traded at a -2% discount relative to its peers on
NTM P/E. We estimate SYNT earnings will grow 13.7% over the next three years
(2009-12E), and our price target implies a 38.3% premium to the earnings CAGR.
Investment Risks
We see the following key risks to our Neutral rating:
• A deteriorating IT services spending environment or an appreciation in Indian
rupee.
• Loss of a large customer, as SYNT's top 10 customers account for 70%+ of
revenue.
• Faster-than-expected ramp in high margin KPO business may drive outperformance.
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