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INFOTECH ENTERPRISES LTD (IEL)
RECOMMENDATION: ACCUMULATE
TARGET PRICE: RS.174
FY12E P/E: 10.4X
Infotech's results were disappointing. While revenues were marginally
below estimates, EBIDTA margins fell QoQ and were significantly below
what we had estimated (excluding impact of one-offs). This is in contrast to
the management's claims of an improvement in margins. We had also
assumed that margins would improve because of the 3% - 5% billing rates
hikes given by the Top 3 clients WEF 4QFY11. We understand that, the
billing rate increases have come in at different times during the quarter and
the full impact is expected to be felt in 1QFY12. The margin performance
reflects the continuing pressure of attrition and salaries on mid-tier
company, which also have to invest in demand generating initiatives.
Overall, we tweak our earnings estimates for FY12. FY12E earnings now
stand at Rs.14.9 per share (Rs.16.8). Consequently, our PT stands revised to
Rs.174 v/s Rs.197 earlier. At our target price FY12 estimates will be
discounted by about 12x. We believe this discount to larger peers is justified
due to the limited visibility on FY12 and pressure on margins. We maintain
ACCUMULATE. We believe that, Infotech will have to address the above
mentioned concerns before we turn more positive on the stock. We are also
concerned about the relatively high proportion of project-based revenues (in
N&CE), in addition to currency fluctuations.
Revenues were up 4% - Volume growth in line
n Revenues for the quarter grew by 4% QoQ. Volumes were 2.7% higher QoQ.
n While ENGG vertical reported a 5.7% rise in volumes, N&CE (Network and Content
Engineering) saw volumes de-grow by 3.7%.
n Infotech bagged 19 new accounts during the quarter of which, 7 were in the
ENGG vertical and the balance in N&CE.
n In N&CE, revenues from Europe were impacted as two of the top 5 clients (BT
and Rural Payment Agency) reduced / tightened their budgets. This is of concern
to us especially in the backdrop of an improving macro demand scenario.
n The company saw traction with a couple of telecom customers and also in revenue
from three new customers. Also, the company had one of the strongest
quarter ever in terms of order intake, which should help revenue growth in FY12.
n Infotech also renewed multi-year agreements with 2 of its Top 10 clients.
n This vertical has been facing continuing client issues. The projects-based nature
of N&CE revenues also adds to the uncertainty.
n During the previous quarter, Infotech had renewed the contract with Tom Tom
for three years at a higher price.
n In ENGG, the revenues from Aerospace Engineering crossed the $100mn annual
mark. The company entered into a strategic partnership with a chip OEM; its
second such partnership in the HiTech space. It also signed a strategic partnership
with a Rail OEM and an Offshore Oil & Gas Major.
n ENGG has been witnessing consistent growth over the past few quarters on the
back of significant new additions and scale up of existing accounts.
n According to the management, the spending in manufacturing industry has
picked up and this has been led by hitech, heavy engineering and aerospace verticals.
n The client budgets are expected to be higher for companies in these three verticals.
Hi-tech and heavy engineering space is expected to see a significant increase
in spend due to the cuts experienced in the previous two years.
n We understand growth came due to the scale up is existing accounts and scale
up in new accounts from Hamilton Sunstrand and Westinghouse. However, the
scale up in Westinghouse will be more gradual.
n Infotech has penetrated the UTC group well with cumulative revenues of more
than $250mn. It now operates at ACE Gold level across all divisions of UTC.
n The company has also been short-listed as one of the off-shore partners for a
new initiative of Caterpillar.
Billing rate increases from Top 3 clients
n Infotech has managed to get 3% - 5% rate increases for off-shore services from
its Top 3 clients during 4QFY11. The full impact is expected to be felt WEF
1QFY12.
n We view this as a significant positive for Infotech. We also see this as a reflection
of the improving macro scene in both service lines.
n This should have a near 1% - 1.2% impact on overall realisations and also allow
the company to improve margins.
EBIDTA margins were a negative surprise; we had expected improvement
QoQ.
n EBITDA margins for the quarter were down on a QoQ basis. This was disappointing,
especially after a steep fall in 1Q and no improvement in 2Q/3Q.
n We had, in fact, assumed an improvement QoQ. This was on the back of the
assumed price increases from the Top 3 clients WEF 4Q.
n The margins were impacted by investments in sales / marketing, according to
the management.
n According to the management, some one time factors (actuarial valuation of
leave / gratuity liability, tear end commissions, low utilization at Daxcon) impacted
margins by about 80bps. Excluding this impact also, margins were much
below our estimates.
n Margin performance of Infotech has been disappointing for the past few quarters
and we see this as a reflection of the challenges faced by mid-tier companies
from attrition and S&M investments, which they are forced to make.
n We had indicated that, salary increments, higher levels of attrition and need to
invest in business generating initiatives will put pressure on margins.
"Other income” and tax
n Infotech reported other income of Rs.51mn, which was lower than our expectations.
n The company has stated that FY11 onwards, its forward contracts qualify for cash
flow hedge accounting, and as such will sit in the exchange fluctuation reserve in
the balance sheet and will be expensed through the P&L as and when they
come up for expiry.
n The company provided tax at the rate of 10% of PBT which was lower QoQ.
Management expects the same to move up to about 30% in FY12E.
Tweak estimates
n We have tweaked our earnings expectations to accommodate the lower than
expected margins in 4QFY11.
n For FY12, we have assumed a revenue growth of about 22%, led by ENGG.
n EBIDTA margins are expected to rise marginally on the back of higher
realisations, capacity utilisation and rightsizing initiatives. These will likely set-off
the impact of salary increases and assumed rupee appreciation, we opine.
n We have assumed tax rate to rise to 29% of PBT in FY12 v/s about 17% in FY11,
in line with the management guidance of 30% - 31%.
n Consequently, PAT is expected to rise by about 19% to Rs.1.66bn, resulting into
an EPS of Rs.14.9.
n We expect the company to have net cash of about Rs.4.6bn by FY12 end, which
works out to Rs.41 per share.
Deep relationships augur well; however margins performance
has to improve
n Infotech has managed to deepen client engagement for clients like UTC, Tom
Tom, P&W, Bombardier, Tele-Atlas & Swisscom over the recent quarters and
enjoys relationships with marquee clients in its verticals.
n Management continues to see opportunities in the higher thrust which aerospace
companies (Bombardier, etc are major clients) are giving to efficient and light
engine design skill sets- areas where IEL has domain expertise and existing impressive
client roster.
n We have in our DCF model built in higher growth rates for Infotech over the
medium term, given the improving demand environment.
n However, margins have a lot of scope for improvement. They have fallen by
800bps over the past 7 quarters and are expected to be further impacted in
1QFY12 due to salary hikes.
n These reflect the challenges of a mid-tier company and we will become more
positive only after seeing a sustained improvement in the same.
Concerns
n A sharp acceleration in the rupee from our assumed levels will impact earnings
estimates negatively for the company.
n Belying of hopes of a pick up in the economic outlook of major user economies
could impact revenue growth of Infotech.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
INFOTECH ENTERPRISES LTD (IEL)
RECOMMENDATION: ACCUMULATE
TARGET PRICE: RS.174
FY12E P/E: 10.4X
Infotech's results were disappointing. While revenues were marginally
below estimates, EBIDTA margins fell QoQ and were significantly below
what we had estimated (excluding impact of one-offs). This is in contrast to
the management's claims of an improvement in margins. We had also
assumed that margins would improve because of the 3% - 5% billing rates
hikes given by the Top 3 clients WEF 4QFY11. We understand that, the
billing rate increases have come in at different times during the quarter and
the full impact is expected to be felt in 1QFY12. The margin performance
reflects the continuing pressure of attrition and salaries on mid-tier
company, which also have to invest in demand generating initiatives.
Overall, we tweak our earnings estimates for FY12. FY12E earnings now
stand at Rs.14.9 per share (Rs.16.8). Consequently, our PT stands revised to
Rs.174 v/s Rs.197 earlier. At our target price FY12 estimates will be
discounted by about 12x. We believe this discount to larger peers is justified
due to the limited visibility on FY12 and pressure on margins. We maintain
ACCUMULATE. We believe that, Infotech will have to address the above
mentioned concerns before we turn more positive on the stock. We are also
concerned about the relatively high proportion of project-based revenues (in
N&CE), in addition to currency fluctuations.
Revenues were up 4% - Volume growth in line
n Revenues for the quarter grew by 4% QoQ. Volumes were 2.7% higher QoQ.
n While ENGG vertical reported a 5.7% rise in volumes, N&CE (Network and Content
Engineering) saw volumes de-grow by 3.7%.
n Infotech bagged 19 new accounts during the quarter of which, 7 were in the
ENGG vertical and the balance in N&CE.
n In N&CE, revenues from Europe were impacted as two of the top 5 clients (BT
and Rural Payment Agency) reduced / tightened their budgets. This is of concern
to us especially in the backdrop of an improving macro demand scenario.
n The company saw traction with a couple of telecom customers and also in revenue
from three new customers. Also, the company had one of the strongest
quarter ever in terms of order intake, which should help revenue growth in FY12.
n Infotech also renewed multi-year agreements with 2 of its Top 10 clients.
n This vertical has been facing continuing client issues. The projects-based nature
of N&CE revenues also adds to the uncertainty.
n During the previous quarter, Infotech had renewed the contract with Tom Tom
for three years at a higher price.
n In ENGG, the revenues from Aerospace Engineering crossed the $100mn annual
mark. The company entered into a strategic partnership with a chip OEM; its
second such partnership in the HiTech space. It also signed a strategic partnership
with a Rail OEM and an Offshore Oil & Gas Major.
n ENGG has been witnessing consistent growth over the past few quarters on the
back of significant new additions and scale up of existing accounts.
n According to the management, the spending in manufacturing industry has
picked up and this has been led by hitech, heavy engineering and aerospace verticals.
n The client budgets are expected to be higher for companies in these three verticals.
Hi-tech and heavy engineering space is expected to see a significant increase
in spend due to the cuts experienced in the previous two years.
n We understand growth came due to the scale up is existing accounts and scale
up in new accounts from Hamilton Sunstrand and Westinghouse. However, the
scale up in Westinghouse will be more gradual.
n Infotech has penetrated the UTC group well with cumulative revenues of more
than $250mn. It now operates at ACE Gold level across all divisions of UTC.
n The company has also been short-listed as one of the off-shore partners for a
new initiative of Caterpillar.
Billing rate increases from Top 3 clients
n Infotech has managed to get 3% - 5% rate increases for off-shore services from
its Top 3 clients during 4QFY11. The full impact is expected to be felt WEF
1QFY12.
n We view this as a significant positive for Infotech. We also see this as a reflection
of the improving macro scene in both service lines.
n This should have a near 1% - 1.2% impact on overall realisations and also allow
the company to improve margins.
EBIDTA margins were a negative surprise; we had expected improvement
QoQ.
n EBITDA margins for the quarter were down on a QoQ basis. This was disappointing,
especially after a steep fall in 1Q and no improvement in 2Q/3Q.
n We had, in fact, assumed an improvement QoQ. This was on the back of the
assumed price increases from the Top 3 clients WEF 4Q.
n The margins were impacted by investments in sales / marketing, according to
the management.
n According to the management, some one time factors (actuarial valuation of
leave / gratuity liability, tear end commissions, low utilization at Daxcon) impacted
margins by about 80bps. Excluding this impact also, margins were much
below our estimates.
n Margin performance of Infotech has been disappointing for the past few quarters
and we see this as a reflection of the challenges faced by mid-tier companies
from attrition and S&M investments, which they are forced to make.
n We had indicated that, salary increments, higher levels of attrition and need to
invest in business generating initiatives will put pressure on margins.
"Other income” and tax
n Infotech reported other income of Rs.51mn, which was lower than our expectations.
n The company has stated that FY11 onwards, its forward contracts qualify for cash
flow hedge accounting, and as such will sit in the exchange fluctuation reserve in
the balance sheet and will be expensed through the P&L as and when they
come up for expiry.
n The company provided tax at the rate of 10% of PBT which was lower QoQ.
Management expects the same to move up to about 30% in FY12E.
Tweak estimates
n We have tweaked our earnings expectations to accommodate the lower than
expected margins in 4QFY11.
n For FY12, we have assumed a revenue growth of about 22%, led by ENGG.
n EBIDTA margins are expected to rise marginally on the back of higher
realisations, capacity utilisation and rightsizing initiatives. These will likely set-off
the impact of salary increases and assumed rupee appreciation, we opine.
n We have assumed tax rate to rise to 29% of PBT in FY12 v/s about 17% in FY11,
in line with the management guidance of 30% - 31%.
n Consequently, PAT is expected to rise by about 19% to Rs.1.66bn, resulting into
an EPS of Rs.14.9.
n We expect the company to have net cash of about Rs.4.6bn by FY12 end, which
works out to Rs.41 per share.
Deep relationships augur well; however margins performance
has to improve
n Infotech has managed to deepen client engagement for clients like UTC, Tom
Tom, P&W, Bombardier, Tele-Atlas & Swisscom over the recent quarters and
enjoys relationships with marquee clients in its verticals.
n Management continues to see opportunities in the higher thrust which aerospace
companies (Bombardier, etc are major clients) are giving to efficient and light
engine design skill sets- areas where IEL has domain expertise and existing impressive
client roster.
n We have in our DCF model built in higher growth rates for Infotech over the
medium term, given the improving demand environment.
n However, margins have a lot of scope for improvement. They have fallen by
800bps over the past 7 quarters and are expected to be further impacted in
1QFY12 due to salary hikes.
n These reflect the challenges of a mid-tier company and we will become more
positive only after seeing a sustained improvement in the same.
Concerns
n A sharp acceleration in the rupee from our assumed levels will impact earnings
estimates negatively for the company.
n Belying of hopes of a pick up in the economic outlook of major user economies
could impact revenue growth of Infotech.
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