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KPIT CUMMINS
PRICE: RS.167 RECOMMENDATION: BUY
TARGET PRICE: RS.211 FY13E P/E: 10X
q KPIT's 2QFY12 results were broadly in line with expectations. A higher
other income component led to out-performance on the PAT front. The
5% like-to-like volume growth came on the back of high growth rate sin
the past three quarters. Margins were higher on the back of better capacity
utilization and rupee depreciation and despite some one time 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
should scale up in FY12.
q Strong additions to the pipeline and additions to client acquisition resources
should lead to consistent revenue growth ahead. Company
added strategic accounts with deal value of $100mn. KPIT is now increasingly
focusing on non-linear revenues and has filed about 39 patents. 6-
7% of overall revenues (mostly from auto electronics) 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 once again been delayed and is now expected to be
commercially launched in FY13, we opine. The non-linear nature of revenues
should improve profitability, we believe. We have not yet accounted
for these revenues in our projections.
q We fine tune our FY12E estimates on the back of the changed assumption
on the exchange rate. We also introduce our FY13E estimates. We
expect FY12E earnings at Rs.15.5 per share and Rs.17.5 per share for
FY13E. Our PT stands at Rs.211 based on FY13E earnings (Rs.199 earlier
based on FY12). There could be upsides based on Revolo financials. At
our TP, the stock will be valued at about 14x FY13E earnings, a suitable
discount to larger peers. We maintain BUY.
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.
Like-to-like revenues up 7% QoQ; volumes grow by 5%
n Headline revenue growth was at 2.8% QoQ. However, on a like-to-like basis,
revenues were up by 7%.
n During the quarter, KPIT entered into a definitive agreement to transfer KPIT
Cummins' diversified financial services (DFS) business to Infrasoft Technologies.
This is pursuant to the company's strategy to focus on select verticals, namely
automotive & manufacturing, energy & utilities and defense & government,
n Excluding the impact of this transaction, revenues grew by 4.8% in USD terms
and 7% in INR terms.
n The USD growth was brought about by the volume growth of about 5%, we
understand.
n The volume growth is encouraging when seen in the backdrop of a 4% growth
reported in 1Q and 10% growth reported each in 4Q and 3Q.
n The management received better realizations from new accounts, which were
3% higher than average.
n However, average realizations were flattish after remaining flat in the previous
quarter. Realisations had improved in 3 out of the four quarters in FY11.
New accounts and Cummins
n KPIT is benefiting from the continuing demand in its focus verticals. The company
has been able to win several new orders from existing and new accounts.
n The company achieved a milestone of acquiring strategic customers with consolidated
deal value of USD 100 Million.
n According to the management, the order pipeline is robust.
n Within customers, Cummins account saw revenues grow by 12% QoQ and it
now contributes about 23% of KPIT's revenues.
n Cummins itself is witnessing a revival in its own fortunes and KPIT is looking at
more options to penetrate it further.
n The environment is positive and the company is not experiencing any constraints
in this account.
n KPIT has enough clarity on the work it wants to do within Cummins and expects
to get more orders from this client.
n The like-to-like growth in IES was 4.5% QoQ (DFS was part of IES SBU).
n In IES, the company has witnessed increased traction from existing clients for
Manufacturing Execution Systems (MES), Enterprise Application Integration (EAI)
and testing services.
n The semiconductor business (SSG) revenues have been volatile and have grown
sharply by about 40% QoQ. However, this is on a small base. The revenue for
the quarter was $2.35mn and INR 108mn.
n KPIT plans to continue with the operational improvements which will help in
adjusting the cost structure to be in line with the growth in business volume and
also help in improving the quality of revenues
n In SAP, KPIT continues to see good traction across core ERP, Business Intelligence
(BI), Customer Relationship Management (CRM), Human Capital Management
(HCM) and Application Maintenance & Support (AMS) projects as most deals
have been closed across these offerings.
n The company acquired new accounts spread across different industry verticals
which includes some large value deals of USD 10 Mn+ in the manufacturing &
automotive industry and also a few small size/ mid size deals USD 1 Mn+ for
Energy & Utility companies.
n In the Small & Medium Enterprises (SME) space, KPIT has already started its
engagement with the first customer, while it has signed the second deal in 2Q.
n Geography-wise, US revenues increased by 9.18% QoQ. However, Europe revenues
de-grew by 1.68% after growing at a strong 14% in the previous quarter.
We understand that, Europe revenues may continue to see muted growth in
view of the prevailing economic uncertainty. We will closely watch the evolving
situation in Europe.
Partnership with PACCAR
n KPIT has entered into a partnership with PACCAR, which is a global technology
leader in the design, manufacture and customer support of light, medium and
heavy duty trucks. It launched its first technical center in Pune in partnership with
KPIT Cummins.
n This partnership is a significant achievement as it is one of the largest deals in
our business history and it is spread across different business units.
n The technical center will focus on engineering, IT and component sourcing for
worldwide production and aftermarket operations. The center will employ approximately
200 people.
n We view this as a reflection of the company's capabilities in the automotive sector.
Non-linear revenues is the focus
n The company has been focusing on non-linear initiatives.
n As part of its efforts in this direction, the company has entered into an engagement
with a Japanese Tier I for AUTOSAR license sale for their new vehicle program.
n The company has filed for three more patents during the quarter which takes the
total number of filed patents to 39.
n Currently, about 6-7% of overall revenues (mostly from auto electronics) 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.
SYSTIME integration in progress
n The integration process with SYSTIME is progressing along expected lines.
n According to the management, they have completed the integration of Functional
and practice teams, whereas, operational processes have been streamlined.
n The initial target of KPIT is to rationalize costs by consolidating offices, moving
staff, etc. This process has already started.
n While KPIT has a strong Oracle practice, SYSTIME is a leading JD Edwards
player.
n The company plans to start cross selling opportunities soon and expects business
to flow in from 3QFY12.
n KPIT has started accounting for SYSTIME's profits WEF 2Q. The share of profit
was Rs.28.4mn. It plans to acquire majority stake in SYSTIME by the end of FY12
and the same is expected to be financed by internal accruals.
n We see the acquisition of a 50% stake in SYSTIME (to buy remaining stake over
a 3-year period) as a good strategic fit for KPIT.
n The combined practice will be able to compete more effectively in the Oracle /
JD Edwards market.
n This investment will further strengthen KPIT's offerings in the Manufacturing and
Energy / Utilities verticals, which are focus verticals for the company.
n The investment has brought in 600+ JDE and 200+ Oracle Technology practitioners
from SYSTIME and this will make it a 2000+ strong combined practice.
n Oracle continues to add 400+ customers for JPE every year. This throws open a
big market for KPIT in terms of providing implementation / integration services.
The investment is expected to bring in 25 key customers to KPIT.
n This partnership will also add capabilities in providing solutions and services in
JDE ERP and Hyperion space, to KPIT Cummins' clients, thus increasing the wallet
share of KPIT.
n Moreover, cross selling opportunities of services to SYSTIME clients will further
aid KPIT's growth rates. We believe that, this transaction will be earnings
accretive for KPIT.
REVOLO - no certainty on start of commercial production
n The uncertainty around the launch of REVOLO continues.
n However, the company is looking to have some support from the regulatory side.
We understand that, the launch will happen only after it gets the regulatory support.
n According to the management, Engineering work, Tests & Trials of the entire
solution is complete and the solution is ready to be handed over to the Production
Team.
n Company has expanded its working with multiple manufacturers of lead acid
and lithium ion batteries both in India and abroad.
n The company is currently in conversation with 5 OEMs/ Tier Is along with committed
assignments with 2 OEMs and expects these assignments to continue at
least for the next 2-3 quarters.
n We now expect the commercial production to start sometime in the next fiscal.
n Revolo is a plug-in parallel hybrid solution which will also 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 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.
Employee strength up marginally
n The total employee strength of KPIT stood at 6544 (6584) as at the quarter end.
However, this was after removing the employees of the transferred business of
financial services. Excluding this, we believe that, the company added 160 employees
QoQ.
n The company gave 12 - 14% off-shore salary hikes and 3-4% on-site salary hikes
during the previous quarter.
n Capacity utilization has improved by about 150bps QoQ.
EBITDA Margins - higher on rupee and utilisation
n EBIDTA margins improved QoQ on the back of rupee depreciation and improved
capacity utilization.
n The improvement in margins came in despite the extraordinary expenses (integration
expenses, provision for doubtful debts) of more thanRs.20mn, which were
provided for during the quarter.
n During the quarter, on-site revenues formed a higher proportion of overall revenues.
SAP SBU also continued to be in the investment phases though margins
improved marginally
n We believe that, the company has a few levers which will allow it to improve
margins going ahead.
n The company is operating at about 73% and 91% utilization rates for off-shore
and on-site, which it plans to take up to 73% and 95%, respectively.
n Moreover, it is also looking at a higher off-shore proportion to sustain and improve
margins. Currently, about 53% of revenues come from off-shore services.
KPIT Is also looking at non-linear revenues (39 patents filed) to improve profitability.
n Going forward, if billing rates improve, they may provide further cushion to margins.
The management has also indicated that it will rationalize low-margin, nonfocus
projects with a view to improve profitability.
Change FY12 estimates; Introduce FY13 estimates
n We have fine tuned our FY12 estimates on changed exchange rate assumption.
n We estimate FY12E revenues to grow by 32.5% led by volumes. Realisations are
expected to improve marginally over 1QFY12 levels.
n Margins are expected to be marginally lower YoY. The company has changed
the policy of accounting for pass-through, which will impact margins positively
and so will the rupee depreciation. However, salary hikes may set off that impact.
n PAT is expected to grow by 44% to Rs.1.37bn. The EPS works out to Rs. 15.5.
FY12 earnings are on diluted equity post the preferential allotment to
ChrysCapital
n For FY13, we expect revenues to grow by 16%, largely on the back of revenues.
Rupee is expected to average 46.5 / USD in FY13, which may also have an impact
on margins.
n The company plans to restrict impact on margins through higher utilization levels
and SG&A leverage.
n PAT is expected to grow by 13% to Rs.1.55bn, an EPS of Rs.17.5
Valuations and recommendation
n The stock is currently quoting at 9.5x FY13E earnings.
n We have accorded KPIT valuations higher than comparable peers, based on the
higher revenue growth and potential upsides to margins. Our PT is at Rs.211. At
our target price, KPIT's FY13E earnings will be discounted 14x.
n We maintain BUY.
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
PRICE: RS.167 RECOMMENDATION: BUY
TARGET PRICE: RS.211 FY13E P/E: 10X
q KPIT's 2QFY12 results were broadly in line with expectations. A higher
other income component led to out-performance on the PAT front. The
5% like-to-like volume growth came on the back of high growth rate sin
the past three quarters. Margins were higher on the back of better capacity
utilization and rupee depreciation and despite some one time 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
should scale up in FY12.
q Strong additions to the pipeline and additions to client acquisition resources
should lead to consistent revenue growth ahead. Company
added strategic accounts with deal value of $100mn. KPIT is now increasingly
focusing on non-linear revenues and has filed about 39 patents. 6-
7% of overall revenues (mostly from auto electronics) 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 once again been delayed and is now expected to be
commercially launched in FY13, we opine. The non-linear nature of revenues
should improve profitability, we believe. We have not yet accounted
for these revenues in our projections.
q We fine tune our FY12E estimates on the back of the changed assumption
on the exchange rate. We also introduce our FY13E estimates. We
expect FY12E earnings at Rs.15.5 per share and Rs.17.5 per share for
FY13E. Our PT stands at Rs.211 based on FY13E earnings (Rs.199 earlier
based on FY12). There could be upsides based on Revolo financials. At
our TP, the stock will be valued at about 14x FY13E earnings, a suitable
discount to larger peers. We maintain BUY.
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.
Like-to-like revenues up 7% QoQ; volumes grow by 5%
n Headline revenue growth was at 2.8% QoQ. However, on a like-to-like basis,
revenues were up by 7%.
n During the quarter, KPIT entered into a definitive agreement to transfer KPIT
Cummins' diversified financial services (DFS) business to Infrasoft Technologies.
This is pursuant to the company's strategy to focus on select verticals, namely
automotive & manufacturing, energy & utilities and defense & government,
n Excluding the impact of this transaction, revenues grew by 4.8% in USD terms
and 7% in INR terms.
n The USD growth was brought about by the volume growth of about 5%, we
understand.
n The volume growth is encouraging when seen in the backdrop of a 4% growth
reported in 1Q and 10% growth reported each in 4Q and 3Q.
n The management received better realizations from new accounts, which were
3% higher than average.
n However, average realizations were flattish after remaining flat in the previous
quarter. Realisations had improved in 3 out of the four quarters in FY11.
New accounts and Cummins
n KPIT is benefiting from the continuing demand in its focus verticals. The company
has been able to win several new orders from existing and new accounts.
n The company achieved a milestone of acquiring strategic customers with consolidated
deal value of USD 100 Million.
n According to the management, the order pipeline is robust.
n Within customers, Cummins account saw revenues grow by 12% QoQ and it
now contributes about 23% of KPIT's revenues.
n Cummins itself is witnessing a revival in its own fortunes and KPIT is looking at
more options to penetrate it further.
n The environment is positive and the company is not experiencing any constraints
in this account.
n KPIT has enough clarity on the work it wants to do within Cummins and expects
to get more orders from this client.
n The like-to-like growth in IES was 4.5% QoQ (DFS was part of IES SBU).
n In IES, the company has witnessed increased traction from existing clients for
Manufacturing Execution Systems (MES), Enterprise Application Integration (EAI)
and testing services.
n The semiconductor business (SSG) revenues have been volatile and have grown
sharply by about 40% QoQ. However, this is on a small base. The revenue for
the quarter was $2.35mn and INR 108mn.
n KPIT plans to continue with the operational improvements which will help in
adjusting the cost structure to be in line with the growth in business volume and
also help in improving the quality of revenues
n In SAP, KPIT continues to see good traction across core ERP, Business Intelligence
(BI), Customer Relationship Management (CRM), Human Capital Management
(HCM) and Application Maintenance & Support (AMS) projects as most deals
have been closed across these offerings.
n The company acquired new accounts spread across different industry verticals
which includes some large value deals of USD 10 Mn+ in the manufacturing &
automotive industry and also a few small size/ mid size deals USD 1 Mn+ for
Energy & Utility companies.
n In the Small & Medium Enterprises (SME) space, KPIT has already started its
engagement with the first customer, while it has signed the second deal in 2Q.
n Geography-wise, US revenues increased by 9.18% QoQ. However, Europe revenues
de-grew by 1.68% after growing at a strong 14% in the previous quarter.
We understand that, Europe revenues may continue to see muted growth in
view of the prevailing economic uncertainty. We will closely watch the evolving
situation in Europe.
Partnership with PACCAR
n KPIT has entered into a partnership with PACCAR, which is a global technology
leader in the design, manufacture and customer support of light, medium and
heavy duty trucks. It launched its first technical center in Pune in partnership with
KPIT Cummins.
n This partnership is a significant achievement as it is one of the largest deals in
our business history and it is spread across different business units.
n The technical center will focus on engineering, IT and component sourcing for
worldwide production and aftermarket operations. The center will employ approximately
200 people.
n We view this as a reflection of the company's capabilities in the automotive sector.
Non-linear revenues is the focus
n The company has been focusing on non-linear initiatives.
n As part of its efforts in this direction, the company has entered into an engagement
with a Japanese Tier I for AUTOSAR license sale for their new vehicle program.
n The company has filed for three more patents during the quarter which takes the
total number of filed patents to 39.
n Currently, about 6-7% of overall revenues (mostly from auto electronics) 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.
SYSTIME integration in progress
n The integration process with SYSTIME is progressing along expected lines.
n According to the management, they have completed the integration of Functional
and practice teams, whereas, operational processes have been streamlined.
n The initial target of KPIT is to rationalize costs by consolidating offices, moving
staff, etc. This process has already started.
n While KPIT has a strong Oracle practice, SYSTIME is a leading JD Edwards
player.
n The company plans to start cross selling opportunities soon and expects business
to flow in from 3QFY12.
n KPIT has started accounting for SYSTIME's profits WEF 2Q. The share of profit
was Rs.28.4mn. It plans to acquire majority stake in SYSTIME by the end of FY12
and the same is expected to be financed by internal accruals.
n We see the acquisition of a 50% stake in SYSTIME (to buy remaining stake over
a 3-year period) as a good strategic fit for KPIT.
n The combined practice will be able to compete more effectively in the Oracle /
JD Edwards market.
n This investment will further strengthen KPIT's offerings in the Manufacturing and
Energy / Utilities verticals, which are focus verticals for the company.
n The investment has brought in 600+ JDE and 200+ Oracle Technology practitioners
from SYSTIME and this will make it a 2000+ strong combined practice.
n Oracle continues to add 400+ customers for JPE every year. This throws open a
big market for KPIT in terms of providing implementation / integration services.
The investment is expected to bring in 25 key customers to KPIT.
n This partnership will also add capabilities in providing solutions and services in
JDE ERP and Hyperion space, to KPIT Cummins' clients, thus increasing the wallet
share of KPIT.
n Moreover, cross selling opportunities of services to SYSTIME clients will further
aid KPIT's growth rates. We believe that, this transaction will be earnings
accretive for KPIT.
REVOLO - no certainty on start of commercial production
n The uncertainty around the launch of REVOLO continues.
n However, the company is looking to have some support from the regulatory side.
We understand that, the launch will happen only after it gets the regulatory support.
n According to the management, Engineering work, Tests & Trials of the entire
solution is complete and the solution is ready to be handed over to the Production
Team.
n Company has expanded its working with multiple manufacturers of lead acid
and lithium ion batteries both in India and abroad.
n The company is currently in conversation with 5 OEMs/ Tier Is along with committed
assignments with 2 OEMs and expects these assignments to continue at
least for the next 2-3 quarters.
n We now expect the commercial production to start sometime in the next fiscal.
n Revolo is a plug-in parallel hybrid solution which will also 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 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.
Employee strength up marginally
n The total employee strength of KPIT stood at 6544 (6584) as at the quarter end.
However, this was after removing the employees of the transferred business of
financial services. Excluding this, we believe that, the company added 160 employees
QoQ.
n The company gave 12 - 14% off-shore salary hikes and 3-4% on-site salary hikes
during the previous quarter.
n Capacity utilization has improved by about 150bps QoQ.
EBITDA Margins - higher on rupee and utilisation
n EBIDTA margins improved QoQ on the back of rupee depreciation and improved
capacity utilization.
n The improvement in margins came in despite the extraordinary expenses (integration
expenses, provision for doubtful debts) of more thanRs.20mn, which were
provided for during the quarter.
n During the quarter, on-site revenues formed a higher proportion of overall revenues.
SAP SBU also continued to be in the investment phases though margins
improved marginally
n We believe that, the company has a few levers which will allow it to improve
margins going ahead.
n The company is operating at about 73% and 91% utilization rates for off-shore
and on-site, which it plans to take up to 73% and 95%, respectively.
n Moreover, it is also looking at a higher off-shore proportion to sustain and improve
margins. Currently, about 53% of revenues come from off-shore services.
KPIT Is also looking at non-linear revenues (39 patents filed) to improve profitability.
n Going forward, if billing rates improve, they may provide further cushion to margins.
The management has also indicated that it will rationalize low-margin, nonfocus
projects with a view to improve profitability.
Change FY12 estimates; Introduce FY13 estimates
n We have fine tuned our FY12 estimates on changed exchange rate assumption.
n We estimate FY12E revenues to grow by 32.5% led by volumes. Realisations are
expected to improve marginally over 1QFY12 levels.
n Margins are expected to be marginally lower YoY. The company has changed
the policy of accounting for pass-through, which will impact margins positively
and so will the rupee depreciation. However, salary hikes may set off that impact.
n PAT is expected to grow by 44% to Rs.1.37bn. The EPS works out to Rs. 15.5.
FY12 earnings are on diluted equity post the preferential allotment to
ChrysCapital
n For FY13, we expect revenues to grow by 16%, largely on the back of revenues.
Rupee is expected to average 46.5 / USD in FY13, which may also have an impact
on margins.
n The company plans to restrict impact on margins through higher utilization levels
and SG&A leverage.
n PAT is expected to grow by 13% to Rs.1.55bn, an EPS of Rs.17.5
Valuations and recommendation
n The stock is currently quoting at 9.5x FY13E earnings.
n We have accorded KPIT valuations higher than comparable peers, based on the
higher revenue growth and potential upsides to margins. Our PT is at Rs.211. At
our target price, KPIT's FY13E earnings will be discounted 14x.
n We maintain BUY.
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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