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NIIT TECHNOLOGIES LTD (NIITT)
PRICE: RS.211 RECOMMENDATION: BUY
TARGET PRICE: RS.296 FY13E P/E: 6X
We met the management of NIITT recently. The company continues to
witness good deal flows and the order book continues to be decent. The
company is bidding for a few larger orders in the $10mn - $50mn range. The
new deals won in the recent quarters - Morris, Eurostar - are scaling up
along anticipated lines. The deal from the Police department in India is also
expected to start contributing from 3Q (though largely hardware in 3Q). We
expect the consistent high volume growth of the past few quarters to
continue. The hardware component in two large deals and a higher
employee costs may impact margins. We have tweaked our FY12E and
FY13E estimates to account for the hardware component and employee
costs. Our FY12E EPS stands at Rs.30.6 (31.6) and FY13E EPS stands at Rs.35
(Rs.36.4). Our DCF - based price target stands at Rs.296, based on FY13
earnings (Rs300 earlier). At our TP, our FY13 earnings will be discounted by
about 8.5x which, we believe, is undemanding. We maintain BUY. NIITT has
been achieving consisting revenue growth and margins over the past few
quarters.
Macro scene volatile; no impact on company, as yet
n The company has witnessed volatility in the overall macro scene, especially in
USA and Europe.
n While there are delays in decision making, the company has not seen any
project cancellations. The overall spending on IT is on the rise over the past few
quarters.
n The off-shore component in budgets has increased and this move towards offshoring
is helping Indian vendors who are receiving larger order-flows.
n The management has indicated that, clients are looking at getting more value
from vendors and NIITT is also looking at options of investing in co-development
projects with clients.
n We understand that, BFSI and Travel & Transportation (T&T) verticals continue to
see demand. The retail vertical has also seen traction.
n BFSI is seeing continued spends towards regulatory compliance and also discretionary
spend.
n Within T&T, the airlines vertical has seen a re-emergence of spending. According
to the management, IATA expects the passenger traffic to grow by about 6% in
CY11 and the cargo traffic also by about 6%.
n For Manufacturing and Distribution, the focus is still on supply chain and customers
but significant deal flows are yet to start.
n NIITT is also focusing increasingly on the Indian market. It has already won two
large deals - BFS and the Police Department. It is bidding for two other deals in
the domestic market and sees this as a hedge to the global macro concerns.
n We have not seen any major impact on margins arising from the software component
of the domestic deals - BSF. We will continue to watch the impact, if
any, on the margins in the future.
Large deals have started contributing
n The two large deals signed by NIITT in recent quarters, have started contributing
to revenues.
n The Morris JV earned revenues of Rs.75mn during 2Q and Eurostar's first milestone
has also been delivered.
n The scale-ups have started earlier than expected and we expect further scale ups
in the quarters to come.
n These deals are non-linear in nature and should increase the proportion of revenues
from non-linear revenues in FY12. We expect these to also to give some
cushion to the margins of the company in the medium - to - long term, though
there can be an impact in the short term, especially from the Morris deal.
Non-linear initiatives
n The company continues to focus on non-linear initiatives, which continued to
scale in 2Q.
n Non-linear initiatives formed 27% of overall revenues in 2QFY12 v/s 27% QoQ.
However, with revenues from new deals like Eurostar scaling up WEF 2HFY12,
we expect non-linear revenues to grow as a proportion of revenues over the next
few quarters.
n NIIT's non-linear services can broadly be divided into three parts - managed services
(13% of revenues), platforms and related solutions (14% of revenues) and
cloud services.
n The company has various platforms for the insurance vertical - Subscribe
(ROOM), airlines vertical (revenue accounting) and cargo business (through partners).
n The platform based services should gather steam in the future quarters (with
ROOM's platform gaining traction) while the IMS business is expected to contribute
for the whole fiscal.
n ROOM's revenues have scaled up during the previous quarter. ROOM is more
into the non-life market, which had not been impacted significantly.
n The company has plans of introducing ROOM's platform to the US markets. This
is expected to be done by implementing the PF at the Bermuda location of an
existing European client.
n We expect the entry into US to be slow because of the need to incorporate
changes required by different regulations.
n The company has also launched the SaaS initiative and the Cloud initiative recently.
Initially, it had planned to offer only infrastructure outsourcing services.
n The company has now set up a platform to provide services to co-operative
banks and has already gained its first client.
n These non-linear initiatives are expected to help the company restrict impact on
margins due to salary hikes and potential rupee appreciation, if any.
Margins expected to be lower
n We understand that, margins could be impacted in 2H. The higher proportion of
hardware component from the domestic project as well as from the Eurostar deal
may have an impact.
n The management also indicated that, higher variable pay may have an impact
on the margins. We expect employee costs to be relatively higher in 2H and
FY13E due to higher salaries.
n In 2Q, EBIDTA margins were lower at about 15.8%, on the back of lower profitability
in new projects (Morris and Proyecta) and also the one-time legal and
professional expenses of $2.5mn incurred in the Morris JV.
n Thus, we expect margins to be higher in 3Q v/s 2Q but netting out the one-time
expenses, margins are expected to be lower QoQ.
n The Morris JV is currently not making any margins as it is providing services at
cost levels till the business transfer is completed. This is expected to continue till
1QFY13 after which, we expect normalized margins from this business.
n We understand that, Proyecta business had about 8 - 9% EBIDTA margins in 2Q.
Future prospects
n We have incorporated some changes in our earnings estimates for FY12E and
FY13E.
n We have assumed some hardware revenues in 2HFY12 and have also incorporated
some pressure on margins due to the higher employee costs.
n We have assumed the rupee to average 48 / USD in 2HFY12 and 46.5 / USD in
FY13E.
n We have assumed the tax rate to 26% of PBT as STPI unit benefits are expected
to expire WEF FY12.
n Consequently, PAT is expected to rise to Rs.1.82bn in FY12E and Rs.2.08bn in
FY13E.
Valuations and recommendation
n In our DCF model, we have incorporated a benign operating environment in our
near term assumptions for the company.
n A WACC of 15% and terminal growth of 2% leads us to a fair value of 296
(Rs.300) for the stock, based on FY13 estimates.
n At those levels the stock will quote at about 8.5x FY13 earnings, which is reasonable,
in our view.
n We maintain a BUY.
n The company may have net cash of about Rs.63 per share by FY13 end, as per
our estimates.
Concerns
n Rupee appreciation beyond our assumed levels could provide a downward bias
to our earnings estimates.
n A delayed recovery in major global economies could impact growth prospects of
NIITT.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
NIIT TECHNOLOGIES LTD (NIITT)
PRICE: RS.211 RECOMMENDATION: BUY
TARGET PRICE: RS.296 FY13E P/E: 6X
We met the management of NIITT recently. The company continues to
witness good deal flows and the order book continues to be decent. The
company is bidding for a few larger orders in the $10mn - $50mn range. The
new deals won in the recent quarters - Morris, Eurostar - are scaling up
along anticipated lines. The deal from the Police department in India is also
expected to start contributing from 3Q (though largely hardware in 3Q). We
expect the consistent high volume growth of the past few quarters to
continue. The hardware component in two large deals and a higher
employee costs may impact margins. We have tweaked our FY12E and
FY13E estimates to account for the hardware component and employee
costs. Our FY12E EPS stands at Rs.30.6 (31.6) and FY13E EPS stands at Rs.35
(Rs.36.4). Our DCF - based price target stands at Rs.296, based on FY13
earnings (Rs300 earlier). At our TP, our FY13 earnings will be discounted by
about 8.5x which, we believe, is undemanding. We maintain BUY. NIITT has
been achieving consisting revenue growth and margins over the past few
quarters.
Macro scene volatile; no impact on company, as yet
n The company has witnessed volatility in the overall macro scene, especially in
USA and Europe.
n While there are delays in decision making, the company has not seen any
project cancellations. The overall spending on IT is on the rise over the past few
quarters.
n The off-shore component in budgets has increased and this move towards offshoring
is helping Indian vendors who are receiving larger order-flows.
n The management has indicated that, clients are looking at getting more value
from vendors and NIITT is also looking at options of investing in co-development
projects with clients.
n We understand that, BFSI and Travel & Transportation (T&T) verticals continue to
see demand. The retail vertical has also seen traction.
n BFSI is seeing continued spends towards regulatory compliance and also discretionary
spend.
n Within T&T, the airlines vertical has seen a re-emergence of spending. According
to the management, IATA expects the passenger traffic to grow by about 6% in
CY11 and the cargo traffic also by about 6%.
n For Manufacturing and Distribution, the focus is still on supply chain and customers
but significant deal flows are yet to start.
n NIITT is also focusing increasingly on the Indian market. It has already won two
large deals - BFS and the Police Department. It is bidding for two other deals in
the domestic market and sees this as a hedge to the global macro concerns.
n We have not seen any major impact on margins arising from the software component
of the domestic deals - BSF. We will continue to watch the impact, if
any, on the margins in the future.
Large deals have started contributing
n The two large deals signed by NIITT in recent quarters, have started contributing
to revenues.
n The Morris JV earned revenues of Rs.75mn during 2Q and Eurostar's first milestone
has also been delivered.
n The scale-ups have started earlier than expected and we expect further scale ups
in the quarters to come.
n These deals are non-linear in nature and should increase the proportion of revenues
from non-linear revenues in FY12. We expect these to also to give some
cushion to the margins of the company in the medium - to - long term, though
there can be an impact in the short term, especially from the Morris deal.
Non-linear initiatives
n The company continues to focus on non-linear initiatives, which continued to
scale in 2Q.
n Non-linear initiatives formed 27% of overall revenues in 2QFY12 v/s 27% QoQ.
However, with revenues from new deals like Eurostar scaling up WEF 2HFY12,
we expect non-linear revenues to grow as a proportion of revenues over the next
few quarters.
n NIIT's non-linear services can broadly be divided into three parts - managed services
(13% of revenues), platforms and related solutions (14% of revenues) and
cloud services.
n The company has various platforms for the insurance vertical - Subscribe
(ROOM), airlines vertical (revenue accounting) and cargo business (through partners).
n The platform based services should gather steam in the future quarters (with
ROOM's platform gaining traction) while the IMS business is expected to contribute
for the whole fiscal.
n ROOM's revenues have scaled up during the previous quarter. ROOM is more
into the non-life market, which had not been impacted significantly.
n The company has plans of introducing ROOM's platform to the US markets. This
is expected to be done by implementing the PF at the Bermuda location of an
existing European client.
n We expect the entry into US to be slow because of the need to incorporate
changes required by different regulations.
n The company has also launched the SaaS initiative and the Cloud initiative recently.
Initially, it had planned to offer only infrastructure outsourcing services.
n The company has now set up a platform to provide services to co-operative
banks and has already gained its first client.
n These non-linear initiatives are expected to help the company restrict impact on
margins due to salary hikes and potential rupee appreciation, if any.
Margins expected to be lower
n We understand that, margins could be impacted in 2H. The higher proportion of
hardware component from the domestic project as well as from the Eurostar deal
may have an impact.
n The management also indicated that, higher variable pay may have an impact
on the margins. We expect employee costs to be relatively higher in 2H and
FY13E due to higher salaries.
n In 2Q, EBIDTA margins were lower at about 15.8%, on the back of lower profitability
in new projects (Morris and Proyecta) and also the one-time legal and
professional expenses of $2.5mn incurred in the Morris JV.
n Thus, we expect margins to be higher in 3Q v/s 2Q but netting out the one-time
expenses, margins are expected to be lower QoQ.
n The Morris JV is currently not making any margins as it is providing services at
cost levels till the business transfer is completed. This is expected to continue till
1QFY13 after which, we expect normalized margins from this business.
n We understand that, Proyecta business had about 8 - 9% EBIDTA margins in 2Q.
Future prospects
n We have incorporated some changes in our earnings estimates for FY12E and
FY13E.
n We have assumed some hardware revenues in 2HFY12 and have also incorporated
some pressure on margins due to the higher employee costs.
n We have assumed the rupee to average 48 / USD in 2HFY12 and 46.5 / USD in
FY13E.
n We have assumed the tax rate to 26% of PBT as STPI unit benefits are expected
to expire WEF FY12.
n Consequently, PAT is expected to rise to Rs.1.82bn in FY12E and Rs.2.08bn in
FY13E.
Valuations and recommendation
n In our DCF model, we have incorporated a benign operating environment in our
near term assumptions for the company.
n A WACC of 15% and terminal growth of 2% leads us to a fair value of 296
(Rs.300) for the stock, based on FY13 estimates.
n At those levels the stock will quote at about 8.5x FY13 earnings, which is reasonable,
in our view.
n We maintain a BUY.
n The company may have net cash of about Rs.63 per share by FY13 end, as per
our estimates.
Concerns
n Rupee appreciation beyond our assumed levels could provide a downward bias
to our earnings estimates.
n A delayed recovery in major global economies could impact growth prospects of
NIITT.
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