Cyient Ltd - Q2FY15 Result Update - Impressive growth, but recent re-rating limits upside :: Centrum

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Rating: Hold; Target Price: Rs530; CMP: Rs447; Upside: 18.6%



Impressive growth, but recent re-rating limits upside



Cyient reported revenue growth significantly ahead of our expectations
with strong growth both onsite and offshore. Organic growth at 5.3%
QoQ and 20.7% YoY (in USD terms) was impressive. Margins recovered
partially helped by utilisation and offshore ratio both of which
improved for Data Transformation, Network and Operations (DNO). The
temporary increase in sub-contracting costs onsite for a DNO project
continued this quarter as well. We increase revenue estimates, cut
margin estimates on higher sub-contracting expenses and maintain Hold
with a new TP of Rs530 based on 11xSep-16E EPS.

$ Good revenue growth even excluding Softential: Cyient’s revenue was
much ahead of our expectations as onsite revenue proportion remained
high in DNO (though down 100bpsQoQ). DNO onsite revenues increased
through Softential’s contribution while offshore grew at an impressive
12.7% QoQ in USD terms showing the potential of the utilities contract
that is still ramping up. Engineering also showed good growth at 4.5%
QoQ in USD terms led by Aero & Defence, Semiconductor and Off-Highway
while Medical & Consumer Electronics (an area that is not considered a
strategic priority anymore by Cyient) declined.

$ Margin recovery only partial with sub-contracting and utilisation
drags: DNO continues to see some onsite work that has become a larger
component of revenue than expected. While DNO utilisations have begun
to normalise this quarter, Engineering utilisation declined 160bps
QoQ. A pleasant surprise was the 3.3% QoQ improvement in engineering
realisation. We expect margins to continue to recover through 2HFY15E
helped by utilisation improvements in Engineering and DNO as well as
slightly lower sub-contracting costs and good control on operating
expenses. We still expect FY15E margins to be soft expecting a nearly
three-fold increase YoY in sub-contracting expenses.

$ Strong non-top-10 growth in Q2 follows good growth in Top accounts
in Q1:  Last quarter, we pointed out that Cyient’s focus on improving
account management had started paying off with Top-5 up 19.6% YoY in
USD terms and Top 6-10 up an impressive 43.8% YoY. While growth in
Top-5 and Top 6-10 was relatively muted this quarter at 1.4% and 1.1%
respectively in USD terms (compared to  8.8% and 10.1% last quarter),
we are enthused by 9.0% growth in the non-Top-10 accounts even if the
entire increase in Softential revenue came in non-top-10 accounts. We
also note broad-based growth across verticals.

$ Improved traction has already driven re-rating; maintain Hold:
While we continue to expect margins to recover over coming quarters,
revenue growth will be only about 14.1% in USD terms over FY16E. After
the significant re-rating since 1QFY15 results, we think further
multiple expansion is difficult and maintain Hold with a new TP of
Rs530 based on 11x Sep-16E EPS. Key upside risk to our call comes from
the possibility of further re-rating after clarity emerges on defence
offset through services procurement. Key downside risks are
significant rupee appreciation or key client loss.



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