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KPIT CUMMINS
RECOMMENDATION: BUY
TARGET PRICE: RS.207
FY12E P/E: 12X
q KPIT's 4Q results PAT were better than our estimates. Revenues grew by
13% QoQ. The 10% volume growth was impressive and came on the
back of a 10% rise in 3Q. As in 3Q, the QoQ volume growth was much
higher than industry peers. Margins were largely flat QoQ, excluding the
impact of one-off provisions and integration expenses.
q Management commentary suggests decent visibility on revenues going
ahead. We opine that, the company is strategically well positioned with
focus verticals doing well. It has also made well - directed acquisitions
which should help it penetrate clients and geographies. These acquisitions
have been integrated and should scale up in FY12.
q Strong additions to the pipeline and additions to client acquisition resources
should lead to consistent revenue growth ahead. KPIT is now increasingly
focusing on non-linear revenues and has filed about 34 patents.
5-7% of auto electronics revenues currently accrue from non-linear
initiatives. KPIT plans to have 25% of revenues from these initiatives in 3
years' time. We believe this is an important lever to protect and sustain
margins.
q Revolo's launch has been delayed and is now expected to be commercially
launched in 2QFY12 and should add to the growth in that fiscal.
The company is already in talks with OEMs, sales channels and
corporates. The non-linear nature of revenues should improve profitability,
we believe. We have not yet accounted for these revenues in our projections.
q KPIT continues to be impacted by high attrition (22% on an annual basis,
down from 30% in 3Q though) and has been forced to spend additionally
on recruitment and training.
q We make changes to our FY12 earnings estimates in light of improved
demand conditions. PAT is expected to grow by 32% YoY. Our earnings
estimates stand at Rs. 14.3 (Rs.14.4) per share. We increase our PT to
Rs.207 (Rs.196), based on FY12E earnings, reflecting increased optimism
on business velocity. At our TP, the stock will be valued at about 14.5x
FY12E earnings, a suitable discount to larger peers.
q Belied hopes of volume-led-growth in IT services demand in major user
economies and a sharper-than-expected appreciation in rupee remain the
key risks for earnings. Revolo earnings can provide significant upsides, if
successful.
Revenues - up 12.6% QoQ; volumes grow by 10%
n Revenues grew by about 13%, largely on the back of volumes.
n According to the management, volumes grew by about 10% (10%) QoQ, which
was better than our expectations.
n In fact, volume growth is better than the growth rates reported by industry peers.
It looks particularly attractive when seen in the backdrop of an 8% growth reported
in 2Q and a 10% rise in 3Q.
n Average realizations were higher after a flat 3Q but successive improvements in
the previous two quarters. This rise in realizations was due to a change in mix in
favour of higher-end businesses like auto embedded technologies, enterprise solutions
and semi-conductor solutions. The company also was able to get higher
rates from existing and new accounts.
n KPIT is benefiting from a revival in demand in its focus verticals.
n The company has been able to win several new orders from existing accounts.
The Top 10 clients gave 13% more revenues QoQ. In 4Q, the company had won
three accounts.
n The semiconductor business (SSG) bounced back with a 33% QoQ rise after witnessing
a moderation in the previous quarter. We understand that, there was no
major one-off component to this growth.
n The company is consistently focusing on improving the volume of business for
SSG customers, by strengthening its front end team & account management process
and also emphasizing on new delivery models.
n The 10% rise in volumes is similar to the growth of 3Q and an 8% growth in
2QFY11 and indicates continuing traction in business.
n We believe that, the company should be able to achieve better growth rates and
the order book gets executed in future quarters.
n According to the management, the order pipeline is robust.
n The growth in focus verticals of Manufacturing indicates higher traction in that
business. This vertical had witnessed extended decision making cycles for smaller
payers focused on verticals ex-BFSI, given the challenging macro-environment.
n We note the manufacturing vertical contributes c78% of revenues; traction in
this vertical should auger well for the company going ahead.
n Industry peers have also indicated a revival in manufacturing and hi-tech / R&D.
n Revenues from Cummins fell QoQ after growing by 22% in 3Q. 3Q contained
some project closures which had increase the revenues for that quarter.
n According to the management, the worst may be over as far as the Cummins
account is concerned. Revenues in IT and engineering services are expected to
scale up in this account for KPIT.
n We believe consistent and effective account management of non Cummins clients
is necessary for broad based revenue growth.
Employee strength up. Attrition rates moderate but the pressure
is still on
n The total employee strength of KPIT stood at 6514 (6229) as at the quarter end.
Capacity utilization was higher on a sequential basis.
n Though the attrition rate moderated to about 22% v/s 30% in 3Q, the pressure
is still high, according to the management.
n This is adequately reflected in the 12 - 14% off-shore salary hikes and 3-4% onsite
salary hikes being given by the company.
n The salary hikes are expected to cool down attrition in 1Q, but it is expected to
shoot up in the following quarters.
n Mid-sized companies are facing higher attrition due to the buoyancy in the industry
and aggressive hiring by large companies.
n The management is looking at replacing these with freshers and thus gaining
cost advantages. However, this can also impact the delivery and impact overall
productivity.
EBITDA Margins - flattish, excluding one-offs and integration expenses
n EBITDA margins in 4QFY11 were marginally lower QoQ, excluding the impact of
one-offs and integration expenses. The company made a provision for bad and
doubtful debts of about Rs.22mn in 4Q.
n Also, 3Q and 4Q contained integration expenses of $1mn and $0.50mn, respectively.
n Going forward, we expect margins to move higher in FY12 v/s 4QFY11 as utilization
rates improve, M&A expenses reduce, billing rates improve and scale benefits
accrue.
n The management has also indicated that it will rationalize low-margin, non-focus
projects with a view to improve profitability.
n The company has disclosed that the total amount of hedges at the end of
4QFY11 are $61.5mn ($73mn). Of these, hedges maturing in the next 3 months
are $7.5mn The company has disclosed that the average hedge rate for FY12 is
Rs.45/USD.
Revolo - delayed to 2Q
n The company is conducting road tests of pilot vehicles as well as consumer vehicles.
n Moreover, the company has significantly reduced the weight of the product from
about 220kgs to about 150kgs.
n The durability has been improved and the company has also standardized many
components across the vehicle range.
n Construction at the assembly and manufacturing location (under Impact Automotive
Solutions Pvt. Ltd., the JV with Bharat Forge).at Hinjewadi is expected to be
complete by Q2FY12.
n KPIT plans to launch the product on two products initially - 800cc and 3litre diesel
cars, we understand.
n KPIT's focus on moving up the value chain in focus verticals has led to the company
filing 27 patents till date and the development of Revolo.
n Revolo is a plug-in parallel hybrid solution which will also make the motor and
engine to work simultaneously.
n This has been developed in-house by KPIT and will be manufactured in a 50 : 50
JV with Bharat Forge.
n While KPIT will bring in its IP, Bharat Forge is expected to bring in its manufacturing
capabilities.
n The product has already been tested on various four-wheelers by Automotive
Regulatory Authority of India (ARAI).
n The company is already in talks with OEMs, corporates and sales channels for
sealing sales deals.
n The equity investments are expected to be Rs.1bn in the JV and commercial production
is expected to start byFY11 end.
n KPIT expects the JV's revenues to be Rs.3bn - Rs.5bn in the second year of operation,
based on an average realization of Rs.0.10mn per piece.
n We understand that, with an estimated pay-back period of about 2.5 - 3 years
for commercial operators and the focus on green technologies, the product has
the potential to be successful.
n We have not assumed any revenues from this JV in our estimates.
Change FY12 estimates
n We have made changes in our estimates to account for the 4QFY11 results.
n We estimate FY12E revenues to grow by 32.5% led by volumes. Realisations are
expected to improve marginally over 4QFY11 levels.
n Margins are expected to be marginally lower YoY. The salary hikes WEF April
2011 and the impact of the rupee (assumed at Rs.45/USD for FY12) will impact
margins.
n However, the company plans to restrict impact on margins through higher utilization
levels (200-300bps according to the management), better realizations,
SG&A leverage and rationalization of low-margin business which came in as a
part of acquisitions.
n With higher other income and a higher tax rate (24% v/s 14% YoY), PAT is expected
to grow by 32% to Rs.1.25bn. The EPS works out to Rs. Rs.14.4. FY12
earnings are on diluted equity post the preferential allotment to ChrysCapital.
Valuations and recommendation
n The stock is currently quoting at 12x FY12E earnings.
n We have accorded KPIT valuations higher than comparable peers, based on the
higher revenue growth and potential upsides to margins. At our target price,
KPIT's FY12E earnings will be discounted 14.5x.
n We maintain BUY with a revised PT of Rs.207 (Rs.196).
Risks and concerns
Belied hopes of volume-led-growth in IT services demand in major user economies
and a sharper-than-expected appreciation in rupee remain the key risks for earnings.
Revolo earnings can provide significant upsides, if successful.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
KPIT CUMMINS
RECOMMENDATION: BUY
TARGET PRICE: RS.207
FY12E P/E: 12X
q KPIT's 4Q results PAT were better than our estimates. Revenues grew by
13% QoQ. The 10% volume growth was impressive and came on the
back of a 10% rise in 3Q. As in 3Q, the QoQ volume growth was much
higher than industry peers. Margins were largely flat QoQ, excluding the
impact of one-off provisions and integration expenses.
q Management commentary suggests decent visibility on revenues going
ahead. We opine that, the company is strategically well positioned with
focus verticals doing well. It has also made well - directed acquisitions
which should help it penetrate clients and geographies. These acquisitions
have been integrated and should scale up in FY12.
q Strong additions to the pipeline and additions to client acquisition resources
should lead to consistent revenue growth ahead. KPIT is now increasingly
focusing on non-linear revenues and has filed about 34 patents.
5-7% of auto electronics revenues currently accrue from non-linear
initiatives. KPIT plans to have 25% of revenues from these initiatives in 3
years' time. We believe this is an important lever to protect and sustain
margins.
q Revolo's launch has been delayed and is now expected to be commercially
launched in 2QFY12 and should add to the growth in that fiscal.
The company is already in talks with OEMs, sales channels and
corporates. The non-linear nature of revenues should improve profitability,
we believe. We have not yet accounted for these revenues in our projections.
q KPIT continues to be impacted by high attrition (22% on an annual basis,
down from 30% in 3Q though) and has been forced to spend additionally
on recruitment and training.
q We make changes to our FY12 earnings estimates in light of improved
demand conditions. PAT is expected to grow by 32% YoY. Our earnings
estimates stand at Rs. 14.3 (Rs.14.4) per share. We increase our PT to
Rs.207 (Rs.196), based on FY12E earnings, reflecting increased optimism
on business velocity. At our TP, the stock will be valued at about 14.5x
FY12E earnings, a suitable discount to larger peers.
q Belied hopes of volume-led-growth in IT services demand in major user
economies and a sharper-than-expected appreciation in rupee remain the
key risks for earnings. Revolo earnings can provide significant upsides, if
successful.
Revenues - up 12.6% QoQ; volumes grow by 10%
n Revenues grew by about 13%, largely on the back of volumes.
n According to the management, volumes grew by about 10% (10%) QoQ, which
was better than our expectations.
n In fact, volume growth is better than the growth rates reported by industry peers.
It looks particularly attractive when seen in the backdrop of an 8% growth reported
in 2Q and a 10% rise in 3Q.
n Average realizations were higher after a flat 3Q but successive improvements in
the previous two quarters. This rise in realizations was due to a change in mix in
favour of higher-end businesses like auto embedded technologies, enterprise solutions
and semi-conductor solutions. The company also was able to get higher
rates from existing and new accounts.
n KPIT is benefiting from a revival in demand in its focus verticals.
n The company has been able to win several new orders from existing accounts.
The Top 10 clients gave 13% more revenues QoQ. In 4Q, the company had won
three accounts.
n The semiconductor business (SSG) bounced back with a 33% QoQ rise after witnessing
a moderation in the previous quarter. We understand that, there was no
major one-off component to this growth.
n The company is consistently focusing on improving the volume of business for
SSG customers, by strengthening its front end team & account management process
and also emphasizing on new delivery models.
n The 10% rise in volumes is similar to the growth of 3Q and an 8% growth in
2QFY11 and indicates continuing traction in business.
n We believe that, the company should be able to achieve better growth rates and
the order book gets executed in future quarters.
n According to the management, the order pipeline is robust.
n The growth in focus verticals of Manufacturing indicates higher traction in that
business. This vertical had witnessed extended decision making cycles for smaller
payers focused on verticals ex-BFSI, given the challenging macro-environment.
n We note the manufacturing vertical contributes c78% of revenues; traction in
this vertical should auger well for the company going ahead.
n Industry peers have also indicated a revival in manufacturing and hi-tech / R&D.
n Revenues from Cummins fell QoQ after growing by 22% in 3Q. 3Q contained
some project closures which had increase the revenues for that quarter.
n According to the management, the worst may be over as far as the Cummins
account is concerned. Revenues in IT and engineering services are expected to
scale up in this account for KPIT.
n We believe consistent and effective account management of non Cummins clients
is necessary for broad based revenue growth.
Employee strength up. Attrition rates moderate but the pressure
is still on
n The total employee strength of KPIT stood at 6514 (6229) as at the quarter end.
Capacity utilization was higher on a sequential basis.
n Though the attrition rate moderated to about 22% v/s 30% in 3Q, the pressure
is still high, according to the management.
n This is adequately reflected in the 12 - 14% off-shore salary hikes and 3-4% onsite
salary hikes being given by the company.
n The salary hikes are expected to cool down attrition in 1Q, but it is expected to
shoot up in the following quarters.
n Mid-sized companies are facing higher attrition due to the buoyancy in the industry
and aggressive hiring by large companies.
n The management is looking at replacing these with freshers and thus gaining
cost advantages. However, this can also impact the delivery and impact overall
productivity.
EBITDA Margins - flattish, excluding one-offs and integration expenses
n EBITDA margins in 4QFY11 were marginally lower QoQ, excluding the impact of
one-offs and integration expenses. The company made a provision for bad and
doubtful debts of about Rs.22mn in 4Q.
n Also, 3Q and 4Q contained integration expenses of $1mn and $0.50mn, respectively.
n Going forward, we expect margins to move higher in FY12 v/s 4QFY11 as utilization
rates improve, M&A expenses reduce, billing rates improve and scale benefits
accrue.
n The management has also indicated that it will rationalize low-margin, non-focus
projects with a view to improve profitability.
n The company has disclosed that the total amount of hedges at the end of
4QFY11 are $61.5mn ($73mn). Of these, hedges maturing in the next 3 months
are $7.5mn The company has disclosed that the average hedge rate for FY12 is
Rs.45/USD.
Revolo - delayed to 2Q
n The company is conducting road tests of pilot vehicles as well as consumer vehicles.
n Moreover, the company has significantly reduced the weight of the product from
about 220kgs to about 150kgs.
n The durability has been improved and the company has also standardized many
components across the vehicle range.
n Construction at the assembly and manufacturing location (under Impact Automotive
Solutions Pvt. Ltd., the JV with Bharat Forge).at Hinjewadi is expected to be
complete by Q2FY12.
n KPIT plans to launch the product on two products initially - 800cc and 3litre diesel
cars, we understand.
n KPIT's focus on moving up the value chain in focus verticals has led to the company
filing 27 patents till date and the development of Revolo.
n Revolo is a plug-in parallel hybrid solution which will also make the motor and
engine to work simultaneously.
n This has been developed in-house by KPIT and will be manufactured in a 50 : 50
JV with Bharat Forge.
n While KPIT will bring in its IP, Bharat Forge is expected to bring in its manufacturing
capabilities.
n The product has already been tested on various four-wheelers by Automotive
Regulatory Authority of India (ARAI).
n The company is already in talks with OEMs, corporates and sales channels for
sealing sales deals.
n The equity investments are expected to be Rs.1bn in the JV and commercial production
is expected to start byFY11 end.
n KPIT expects the JV's revenues to be Rs.3bn - Rs.5bn in the second year of operation,
based on an average realization of Rs.0.10mn per piece.
n We understand that, with an estimated pay-back period of about 2.5 - 3 years
for commercial operators and the focus on green technologies, the product has
the potential to be successful.
n We have not assumed any revenues from this JV in our estimates.
Change FY12 estimates
n We have made changes in our estimates to account for the 4QFY11 results.
n We estimate FY12E revenues to grow by 32.5% led by volumes. Realisations are
expected to improve marginally over 4QFY11 levels.
n Margins are expected to be marginally lower YoY. The salary hikes WEF April
2011 and the impact of the rupee (assumed at Rs.45/USD for FY12) will impact
margins.
n However, the company plans to restrict impact on margins through higher utilization
levels (200-300bps according to the management), better realizations,
SG&A leverage and rationalization of low-margin business which came in as a
part of acquisitions.
n With higher other income and a higher tax rate (24% v/s 14% YoY), PAT is expected
to grow by 32% to Rs.1.25bn. The EPS works out to Rs. Rs.14.4. FY12
earnings are on diluted equity post the preferential allotment to ChrysCapital.
Valuations and recommendation
n The stock is currently quoting at 12x FY12E earnings.
n We have accorded KPIT valuations higher than comparable peers, based on the
higher revenue growth and potential upsides to margins. At our target price,
KPIT's FY12E earnings will be discounted 14.5x.
n We maintain BUY with a revised PT of Rs.207 (Rs.196).
Risks and concerns
Belied hopes of volume-led-growth in IT services demand in major user economies
and a sharper-than-expected appreciation in rupee remain the key risks for earnings.
Revolo earnings can provide significant upsides, if successful.
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