RESULT UPDATE Dipen Shah dipen.shah@kotak.com +91 22 6621 6301 NIIT TECHNOLOGIES LTD (NIITT) PRICE: RS.394 RECOMMENDATION: REDUCE TARGET PRICE: RS.396 FY16E P/E: 10.9X NIITT's operational results were lackluster and came in marginally below our expectations. Continuing delays in a couple of BFSI accounts impacted the revenue growth, which came in at 2.1% QoQ in CC terms. This is the third quarter of flattish-to-low services revenue growth. NIITT needs to tighten its delivery organization further. The order bookings have been encouraging at $103mn ($124mn qoq) and these should translate into better revenue growth, going ahead. The surprise increase in depreciation charge (due to capitalization of AAI projects) has led to a sharp reduction in earnings estimates and TP to Rs.396 (Rs.429 earlier). Thus, we recommend REDUCE (ACCUMULATE earlier). NIITT needs to ensure better consistency in revenue growth to attract higher valuations. The company will have net cash of about Rs.77 per share by FY16 end, as per our estimates. Summary table (Rs mn) FY14 FY15E FY16E Sales 23,050 23,380 25,605 Growth (%) 14.0 1.4 9.5 EBITDA 3,516 3,200 3,810 EBITDA margin (%) 15.3 13.7 14.9 PBT 3,185 2,414 3,075 Net profit 2,307 1,710 2,191 EPS (Rs) 38.1 28.1 36.0 Growth (%) 8.1 (25.9) 28.2 CEPS (Rs) 48.3 44.1 53.7 BV (Rs/share) 218.4 233.5 255.1 Dividend / share (Rs) 9.0 12.0 14.0 ROE (%) 19.1 12.5 14.7 ROCE (%) 25.8 16.9 19.5 Net cash (debt) 2,785 3,850 4,707 NW Capital (Days) 89.4 92.6 94.2 P/E (x) 10.3 14.0 10.9 P/BV (x) 1.8 1.7 1.5 EV/Sales (x) 0.9 0.9 0.7 EV/EBITDA (x) 6.0 6.3 5.0 Source: Company, Kotak Securities - Private Client Research 2QFY15 results (Rs mn) 1QFY15 2QFY15 % Chg 2QFY14 % Chg Income 5,776 5,883 1.9 5,512 6.7 Expenditure 5,001 5,061 4,569 Operating Profit 775 822 6.1 944-12.9 Depreciation 189 254 155 Gross Profit 586 568-3.1 789-28.0 Interest 0 0 0 Other Income 36-4 182 PBT 622 564-9.3 971-41.9 Tax 162 154 269 PAT 460 410-10.9 702-41.6 Minority interest 27 10 20 Adjusted PAT 433 400-7.6 682-41.3 Shares (mns) 61 61 61 EPS (Rs) 7.1 6.6 11.2 OPM (%) 13.4 14.0 17.1 GPM (%) 10.1 9.7 14.3 NPM (%) 8.0 7.0 12.7 Source : Company Services revenue growth lack-lustre NIITT reported a 2.1% CC growth in services revenues. This follows a flat growth in 1QFY15 and 4QFY14. This is after excluding the hedging gain / loss. Revenues from bought-outs were at Rs.57mn v/s Rs.170mn QoQ. As in 1Q, 2Q revenues were impacted by delays in two projects in BFSI vertical (largely Insurance). These were delayed due to issues specific to the clients and are expected to ramp up in 2H (both accounts). One of the accounts was earlier expected to ramp up in 2Q. GIS revenues, at Rs.318mn, were up QoQ on a low base (1Q is seasonally weak). T&T revenues were up by 9.5% QoQ (13% in INR terms) and provided support to the overall revenues. Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been prepared by the Private Client Group. The views and opinions expressed in this document may or may not match or may be contrary with the views, estimates, rating, target price of the Institutional Equities Research Group of Kotak Securities Limited. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 6
We note that, in addition to 1QFY15 and 2QFY15, 4QFY14 growth was also impacted by a scale-down in one of the large T&T customers, which was undergoing an organizational reorganization process (access to capital markets, etc). We understand that, this had impacted 4QFY14 revenues by a couple of million dollars. Moreover, in the domestic market, the revenue recognition and milestone recognition in one of the large accounts (AAI) was pushed to 1QFY15. We are concerned by the delays in projects and feel that, NIITT needs to tighten its delivery organization to avoid such disappointments in the future. Prospects of T&T good; BFSI remains impacted Within T&T, the airlines vertical has seen stable spending trends, we understand. According to the management, IATA has indicated that, growth in 2015 / 2014 would also be better v/s 2014 / 2013 and it will be the third / second successive year of improving profitability for the industry. NIIT has been able to win market share from larger incumbents, both local and global, which should help improve revenue growth in future quarters. On the other hand, within BFSI, growth in Insurance continues to remain subdued. The insurance vertical in Europe remains impacted. Consequently, NIITT's revenues from that business had been impacted. The business has still not recovered fully and is expected to do so only over 2HFY15. Thus, ROOM (NIITIT) had seen flat revenues for five successive quarters at Rs.409mn in 2Q. Revenues were Rs.410mn in 1Q. Consolidated margins were at about 16% as against 13% in 1QFY15, largely due to rupee depreciation. The vertical remains challenged for NIITT. NIITT is now taking this business global with new contracts already gained in US and ME. The company has gained one large order in US and one in ME. The company has also added mobility and analytics features to the products and has developed a healthy pipeline for the same. We note that, revenues have stabilized in past six / five quarters. However, we are concerned by the consistent underperformance of this vertical. In BFSI, the company is witnessing some challenges. Two clients have delayed projects because of which, the vertical witnessed a fall of 6% in INR terms. While NIITT has been witnessing some challenges in the large BFS accounts, the smaller accounts have continued to scale up. If spending from BFS improves, NIITT may also see demand rising from this vertical. Mr. Sudhir Chaturvedi has come on board now and is expected to rev up growth in this vertical. He is a senior hand in the Financial Services vertical. He last served in Infosys as Senior VP and Head of Financial Services Americas Business Unit. However, revenues from BFSI in the last couple of quarters have disappointed. We will watch out for better execution in this vertical. Sharper focus on growth markets and higher margin businesses Under Mr. Sudhir Chaturvedi, NIITT is sharpening its focus on growth markets as well as on relatively higher margin businesses. We understand that, NIITT is now increasing its focus on the US markets, which currently contributes about 44% to the revenues as against about 60% for the industry. The company plans to increase contribution from US. Thus, the platforms / solutions of NIITIT will now be targeted at customers in US as compared to the earlier focus on European markets only. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 7
On the other hand, it will go slow on the domestic business, which has higher hardware content and hence, lower margins. Thus, we may see the order wins in the domestic market dwindling. In addition to this, NIITT will be deepening its presence as well as expertise in the T&T vertical, where it is one of the leading players from India. We understand that, it is the largest in this vertical after TCS. Apart from the above, NIITT plans to lay more stress on the IMS business, where it does not have any major presence. This is more with a view of filling up the service gaps which are present in the company's portfolio and offer an integrated solutions approach to the client. We believe that, in a rising demand scenario, focusing on growth markets will yield results and should also lead to better margins. However, the company should guard against over-dependence on one segment or geography. Based on the current revenue profile, we believe that, the company does not run this risk in the immediate future. Order booking - high levels sustained One of the positive aspects of the results was the order flow. The order booking for the quarter was at $103mn as against $124mn in 1Q. We note that, the company has now moved on to a higher trajectory of order bookings over the past few quarters and the same will help future revenue growth. The company has been consistently adding orders worth $70mn - $90mn over the past few quarters and now expects this number to stabilize at about $125mn per quarter, going ahead. Non-linear initiatives - pressured due to NIIT Insurance Technologies Non-linear initiatives have remained at about 28% of overall revenues in 2QFY15, we believe. This includes 3% from Non-linear BPO, 16% from Managed Services and 9% from IP assets. Managed Services (MS) revenues have grown from 12% of revenues to 16% of revenues as some of the domestic projects entered the operations & maintenance space (which is MS). AAI project was also completed and entered the MS space in 1Q. Revenues from NIIT Insurance Technologies (Room) have remained impacted. With revenues from new deals like Morris and Eurostar scaling up, we expect non-linear revenues to grow as a proportion of revenues over the next few quarters. Morris had revenues of Rs.406mn in 2Q with margins of 10%. Proyecta brought in revenues of 184mn with margins of 11%. The company has various platforms for the insurance vertical - Subscribe (ROOM), airlines vertical (revenue accounting) and cargo business (through partners). The platform based services should gather steam in the future quarters (with ROOM's platform gaining traction) while the IMS business is also expected to contribute more. The company has also launched the SaaS initiative and the Cloud initiative. The company has already won customers in Asia Pac and the practice should scale up over the next few quarters. These non-linear initiatives are expected to help the company restrict impact on margins due to salary hikes and potential rupee appreciation, if any. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 8
Morris margins improve / GIS flattish GIS revenues were at Rs.318mn (Rs.260mn in a seasonally weak 1Q). The profitability for this business has jumped significantly over the past 2-3 quarters. Margins were at 28% as against 24% in 1Q due to the seasonal impact. We do expect the revenue growth to improve and margins to sustain in the future. Revenues from Morris (NIIT Media Technologies) were marginally higher at Rs.406mn (Rs.390mn in 4Q). Margins were about 10% v/s 16% QoQ, which was very surprising. Margins were higher in 1Q because of the relatively higher off-shore component during the quarter. Employee count - lower QoQ The number of billable employees fell by 7 QoQ, the second successive quarter of reduction. Utilisation rate excluding BPO rose marginally by about 60bps QoQ to 78.6%. The reduction in employees is a negative surprise for us. We believe that, the company can increase the utilization rates only marginally from the current levels. Services margins lower QoQ; below estimates. Depreciation surprises negatively EBIDTA margins in the services business were down by about 104bps QoQ and came in below estimates. The hedging gain was at Rs.96mn v/s a gain of Rs.4.7mn in 1Q. The hardware revenues were also at a lower level of Rs.57mn v/s 1Q levels of Rs.170mn. On the services front, margins were impacted by the slack revenue growth as well as initial expenses towards knowledge transfer, etc for a large order won by the company from an airline customer. Lower Morris margins also impacted overall profitability. Revenue accrual in the AAI project (expenses considered in 4QFY14) had helped in restricting the impact on margins in 1Q. About 40% of NIITT's on-site employees are either US citizens (35%) or have Green Cards. Margins are expected to improve going ahead, as profitability of GIS, NIITIT and Morris improves QoQ. The depreciation charge for the quarter increased from 189mn to 254mn. This was due to the increased depreciation in the AAI projects, where the company capitalized hardware as well as software assets. The company is writing off these assets over a three year period and hence, this charge is expected to sustain and improve marginally over the next three years. This is a negative surprise for us as we had not expected such a high charge. This has impacted our overall profit estimates for the company, especially in FY16 and FY17. NIITT had forex loss of Rs.18mn as against loss of Rs.1mn in 1QFY15. NIITT had investment income of Rs.14mn in 2QFY15 (Rs.37mn in 1QFY15). The yields are relatively lower (cash / equivalents of Rs.2.63bn) likely due to higher amounts in current accounts / foreign accounts / liquid funds. Better allocation may lead to higher yields for the company. The receivables days have fallen from 95 to 90 in 2Q. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 9
Future prospects We expect revenues to grow by 5% YoY in FY15 and by 9% in FY16. Rupee is assumed to average 60/USD in FY15 and 59.5 / USD in FY16. Margins are expected to be lower than FY14 due to the rupee appreciation and salary hikes. Reduced hedging losses in revenues, higher utilization levels and improved margins in Morris/NIITIT/GIS will likely set off some impact. We expect EBIDTA margins in FY16 to be better v/s FY15. With the rupee volatility expected to reduce, hedging losses are expected to be lower. However, the sharp rise in depreciation charge is expected to impact profits. PAT is, thus, expected to amount to Rs.2.19bn in FY16, leading to EPS of Rs.36. We recommend REDUCE on NIIT Technologies with a price target of Rs.396 Valuations and recommendation In our DCF model, we have incorporated a benign operating environment in our near term assumptions for the company. A WACC of 14% and terminal growth of 1% leads us to a fair value of Rs.396 for the stock, on a one-year FW basis (Rs.429 earlier). At those levels the stock will quote at about 10.8x FY16 earnings, which is reasonable, in our view. Looking at the negligible upside in the stock, we now recommend REDUCE in the stock. We are slightly concerned about the revenue growth over the past three quarters. The company will have net cash of about Rs.77 per share by FY16 end, as per our estimates. Concerns Rupee appreciation beyond our assumed levels could provide a downward bias to our earnings estimates. A delayed recovery in major global economies could impact growth prospects of NIITT. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 10