RESULT UPDATE Dipen Shah dipen.shah@kotak.com +91 22 6621 6301 Summary table (Rs mn) FY14 FY15E FY16E Sales 23,050 24,948 27,183 Growth (%) 14.0 8.2 9.0 EBITDA 3,516 4,135 4,452 EBITDA margin (%) 15.3 16.6 16.4 PBT 3,185 3,758 4,127 Net profit 2,307 2,688 2,939 EPS (Rs) 38.1 44.3 48.5 Growth (%) 8.1 16.5 9.4 CEPS (Rs) 48.3 55.4 60.4 BV (Rs/share) 218.4 250.4 284.5 Dividend / share (Rs) 9.0 12.0 14.0 ROE (%) 19.1 18.9 18.1 ROCE (%) 25.8 25.9 25.0 Net cash (debt) 2,785 4,838 6,429 NW Capital (Days) 89.4 91.8 91.9 P/E (x) 10.7 9.2 8.4 P/BV (x) 1.9 1.6 1.4 EV/Sales (x) 1.0 0.8 0.7 EV/EBITDA (x) 6.3 4.8 4.1 Source: Company, Kotak Securities - Private Client Research NIIT TECHNOLOGIES LTD (NIITT) PRICE: RS.409 RECOMMENDATION: BUY TARGET PRICE: RS.467 FY16 PE: 8.4X NIITT's operational results were below estimates. The flat% CC revenue growth in services was lower than what we had expected. A ramp-down in one of the large T&T accounts as well as milestone slippage in a AAI (Airport Authority of India) project, impacted growth. Services margins were lower largely due to the slack revenue growth. The management (under Mr. Sudhir Chaturvedi) is now focusing more on the high growth and high margin businesses, which should bode well for the future. The order bookings have been encouraging at $144mn. In 3Q, NIITT had won a 10-year $300mn renewal deal from one of its large clients, which provides comfort on the company's market positioning as far as large deals are concerned. Expected improvement in profitability of GIS / Morris and improved growth projections by IATA bode well for the prospects of NIITT. Our FY15E and FY16E EPS stand at Rs.44.3 (Rs.41.8) and Rs.48.5, respectively. We assume the rupee to average 60 / USD in FY15 and FY16. Our DCF - based price target stands at Rs.467 (Rs.410) on improved medium-term growth prospects and margins. The stock has remained ranged post 3Q numbers. We recommend BUY (ACCUMULATE). The company will have net cash of about Rs.106 per share by FY16 end, as per our estimates. 4QFY14 results (Rs mn) 3QFY14 4QFY14 % Chg 4QFY13 % Chg Income 5873 5885 0.2 5092 15.6 Expenditure 4916 4994 4214 Operating Profit 957 891-6.9 878 1.5 Depreciation 160 156 161 Gross Profit 797 735-7.8 717 2.5 Interest 0 0 0 Other Income -70-30 -14 PBT 727 705-3.0 703 0.3 Tax 182 56 129 PAT 545 649 19.1 574 13.1 Minority interest 14 29 15 Adjusted PAT 531 620 16.8 559 10.9 Shares (mns) 61 61 61 EPS (Rs) 8.8 10.2 9.2 Margins OPM (%) 16.3 15.1 17.2 GPM (%) 13.6 12.5 14.1 NPM (%) 9.3 11.0 11.3 Source : Company Services revenue growth lower than estimates NIITT reported almost flattish revenues QoQ. Revenues from bought-outs were flat at Rs.230mn sequentially.. The services revenues were flat as well QoQ and were also below our estimates (excluding the hedging losses). This follows a 3.6% CC growth in 3QFY14, which was a seasonally weak quarter. 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 2
4Q growth was impacted by a scale-down in one of the large T&T customers, which is undergoing an organizational reorganization process (access to capital markets, etc). We understand that, this impacted 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. Consequently, revenues from T&T as well as from Rest of World geography fell QoQ. 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 2014 would also be better v/s 2013 and it will be the 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, Insurance had a subdued quarter. The insurance vertical in Europe remains impacted. Consequently, NIITT's revenues from that business has been impacted. The business has not recovered fully as yet and is expected to do so only over FY15. Thus, ROOM (NIITIT) has seen flat revenues for the fourth successive quarter at about Rs.410mn. Consolidated margins were at about 13% as against 18% in 3Q. Thus, 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. We note that, revenues have stabilized in past four quarters. However, we are concerned by the consistent underperformance of this vertical. While NIITT has been witnessing some challenges in the large BFS accounts, the smaller accounts have continued to scale up. The company has been indicating traction from smaller clients in BFS segment (Tower Group, Bankers' Insurance, etc) as well as in some other verticals. These smaller companies are increasingly looking to outsource and off-shore with a view to reduce costs. If spending from BFS improves, NIITT may also see demand rising from this vertical. Insurance is expected to recover in a couple of quarters for NIITT. Mr.Sudhir Chaturvedi has come on board now and he should be able 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. 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 45% 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 Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 3
as compared to the earlier focus on European markets only. 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. GIS margins improve / Morris flattish GIS revenues were seasonally strong at about Rs.310mn (Rs.233mn in 3Q). The profitability for this business has jumped significantly with margins coming in at about 27% as against 13% in 3Q. However, we do expect the revenues and margins to moderate in the next quarter as the benefit of seasonality ebbs. In FY13, GIS business had faced overruns in one APDRP program, which has led to a collapse in margins from >20% to negative 7%. In 3Q, the company had put in additional efforts to conclude the work by 4QFY13. The company plans to take up the margins to between 15% - 20% in due course of time. Revenues from Morris (NIIT Media Technologies) were at Rs.382mn (Rs.376mn in 3Q). Margins were about 13% v/s 11.3% QoQ. Margins were lower in 3Q because of the higher on-site component and employee addition during the quarter. Order book addition - higher One of the positive aspects of the results was the order flow. The order booking of the quarter was at $144mn. 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. The $144mn order booking is as compared to $377mn in 3Q and $84mn in 2Q. In 3Q, NIITT had announced the win of a 10-year $300mn deal from one of its large clients. The deal was won in a vendor rationalization program of the client and includes enhancement, support, maintenance and operations of an existing platform of the client. NIITT will also be providing services related to development and implementation of the new platform. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 4
The deal is a renewal of an existing deal and will bring in additional revenues to the tune of 10%. However, the management has indicated that, the client has already consolidated vendors and hence, further business could come to NIIT, which was earlier going to other vendors. This could lead to more orders in the future quarters. Also, the win of a large order reflects the improved positioning of the company in the market place. We note that, with the reduced focus on domestic hardware-oriented business, order flows may see some moderation in the near term. Non-linear initiatives - pressured due to NIIT Insurance Technologies Non-linear initiatives continue to form about 24% of overall revenues in 4QFY14. This includes 3% from Non-linear BPO, 12% from Managed Services and 9% from IP assets. This is largely due to the fact that, 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. 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. Employee count increased The number of employees increased by about 130 QoQ. Utilisation rate fell by about 110bps to 77.3% in 4Q. We believe that, the company can increase the utilization rates, albeit marginally, from the current levels. Margins lower QoQ EBIDTA margins were down by about 115bps QoQ. The hedging loss at Rs.70mn was similar to 3Q figure of Rs.80mn. The hardware revenues were also at 3Q levels of Rs.230mn. However, because of forex fluctuation, margins in the hardware business were impacted significantly. On the services front also, margins were impacted by the slack revenue growth. Moreover, the company has already incurred the expenditure on the AAI project without corresponding revenues. About 40% of NIITT's on-site employees are either US citizens (35%) or have Green Cards. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 5
Margins are expected to improve going ahead, as profitability of GIS, NIITIT and Morris improves QoQ. NIITT had forex loss of Rs.65mn as against loss of Rs.79mn in 3Q. NIITT had investment income of Rs.34mn in 4QFY14 (Rs.3mn in 3QFY14). The yields are relatively lower (cash / equivalents of Rs.2.87bn) 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 come down to 89 after having increased to 96 in 3Q. The rise in 3Q was due to the non-receipt of funds from the Government. Future prospects We expect revenues to grow by 8.2% YoY in FY15 and by 9% in FY16. Rupee is assumed to average 60/USD in FY15 / FY16. Margins are expected to rise slightly over FY14. The prime reasons are the reduced hedging losses in revenues, higher utilization levels and improved margins in Morris/NIITIT/GIS. With the rupee volatility expected to reduce, hedging losses are expected to be lower. Salary increments and increased S&M expenses are expected to restrict the improvement. PAT is, thus, expected to grow to Rs.2.69bn in FY15 and Rs.2.94bn in FY16, leading to EPS of Rs.44.3 and Rs.48.5, respectively. We recommend BUY on NIIT Technologies with a price target of Rs.467 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.467 for the stock, on a one-year FW basis. At those levels the stock will quote at about 9.6x FY16 earnings, which is reasonable, in our view. The stock has remained range-bound in the recent few weeks in line with the overall sector. We now recommend BUY (ACCUMULATE), looking at the upside from current levels. The company will have net cash of about Rs.106 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 6