CMC Ltd - Initiating Coverage - Skills in government business coming of use

Rating: Buy; Target Price: Rs2,270; CMP: Rs1,826; Upside: 24.3%



Skills in government business coming of use



We initiate on CMC with a Buy rating and a 1-year TP of Rs2,270. CMC’s
growth rate should pick up as the domestic market (~33% of revenues as
of FY14) gets impetus from digital governance initiatives. CMC’s
revenues grew by only 15.8% in FY14 as its India business grew by just
6.6%. We expect international revenues to continue growing faster than
the company average and margins to remain in the 15-17% range. With
RoE of 26%, broad client base of 1,000+ clients and consistent
execution in the past (unlike many Tier-2 firms), we think multiples
comparable to Tier-1 firms can be assigned.

$ International growth to continue, but expecting domestic growth as
well now: International revenues increased to 67.3% of total in FY14
from just 20% in FY03, as a result of a conscious strategy by CMC to
transform its business-mix and margin profile, as well as the poor
demand environment in India that acted as a drag in recent years. We
expect international revenues to continue to grow given CMC’s
differentiation through its focus on Embedded Systems and
asset-leveraged solutions (~18-19% of overall revenue and ~28% of
System Integration revenue). Even the India growth can pick up,
particularly driven by government contracts.

$ CMC’s invaluable experience as a Prime/Lead Contractor in India
timely: With total spending on IT by the GoI estimated to touch
USD6.4Bn over 2014, CMC has great potential. To execute most
government projects, the prime contractor needs to be able to staff
personnel for support and maintenance afterwards in remote areas
(which is unviable unless there is sharing of personnel across clients
for support), an area that CMC has ample experience in. Moreover, TCS
and CMC have partnered for some domestic contracts such as the INR10Bn
Passport Seva Project.

$ Margins could hold up even with increasing domestic contribution:
Domestic contribution could accelerate given renewed focus on
Infrastructure and e-governance by the govt. CMC has experience in
both and also in the cumbersome process of digitisation of manual
government records. With continued growth in its international System
Integration (SI) business and in the high-margin IT-enabled-Services
(ITeS) business, we expect CMC can maintain an EBITDA margin of 15-17%
even as the low-margin domestic Customer Services could grow at
company average.

$ Valuation and key risks: CMC Ltd is currently trading at an implied
Fwd P/E of 15.5x Sep-15E EPS. With improvement in growth in the India
business likely over FY16E, current multiples can improve slightly. We
initiate with Buy and TP of Rs2,270 based on 16x Sep-16E EPS. We think
a premium to traditional Tier-2 firms is justified as the biggest risk
with Tier-2 firms is that of client concentration and CMC had over
1,000 clients as of 3QFY14. One of the key risks is the competition
from TCS, its parent, especially in areas where both have competing
products like BaNCS (for Insurance) from TCS and Genisys from CMC.
Another key risk is the change in immigration and visa norms in the US
(57.1% of CMC’s FY14 revenues).



Thanks & Regards

��

-->