BSE SENSEX S&P CNX 26,026 7,768 Bloomberg KPIT IN Equity Shares (m) 194.9 M.Cap. (INR b) / (USD b) 34.0/0.6 52-Week Range (INR) 191/122 1, 6, 12 Rel. Per (%) 2/-27/4 Financials & Valuation (INR Billion) Y/E Mar 2015E 2016E 2017E Sales 29.5 33.5 37.9 EBITDA 4.4 5.3 6.2 PAT 2.7 3.4 4.2 EPS (INR) 13.5 17.1 21.0 EPS Gr. (%) 7.5 27.0 22.5 BV/Sh. 77.2 94.4 115.3 RoE (%) 19.1 20.0 20.0 RoCE (%) 25.3 25.5 25.7 P/E (x) 12.9 10.2 8.3 EV/EBITDA 6.8 5.0 3.6 22 July 2014 1QFY15 Results Update Sector: Technology CMP: INR175 TP: INR170 Downgrade to Neutral 1QFY15 - significant margin disappointment: KPIT s 1QFY15 margins were a significant disappointment, with EBITDA margin declining 400bp QoQ to 12.1%, v/s our est. of 200bp decline to 14.1%. Gross profit margin declined even more by 550bp QoQ to 26.5% v/s est. of 30%. Revenue grew 1.4% QoQ to USD115.2m, marginally below our estimate of 2.5% QoQ growth to USD116.4m. PAT was INR508m (est. of INR585m) v/s INR515m in 4Q (excluding an exceptional item). Multiple factors dragged profitability: [1] Wage hikes (240bp), [2] Currency (60bp), [3] Onsite mix shift (~60bp), [4] Utilization (40bp), [5] Visa costs (25bp) and [6] I-Cubed acquisition (30bp). Outlook on near term performance: KPIT expects sustained improvement in the operational profitability in the coming quarters aided by growth, utilization and pyramid improvement. However, some promotions and corrections will impact margins in 2Q and 3Q by 50bp and visa costs are spread through the year. 2Q is expected to see significantly better revenue growth on: [1] ramp-up in Telematics deal, [2] execution of multiple deals closed during the quarter and [3] full quarter s impact of I-Cubed acquisition. Cutting estimates: Our EPS estimates are lower by 8.0% for FY15E to INR13.5 and 5.9% for FY16E to INR17.1. We have revised the USD revenue growth, including the acquisition of I-Cubed, now to 12% in FY15E. Our EBITDA margin is revised downwards by 160bp to 14.8% in FY15E and by 100bp to 16% in FY16E. Downgrade rating to Neutral: After a sub-par FY14, 1QFY15 performance poses significant challenges for the company to converge the performance gap with peers over the medium term. In congruence with the performance, we expect the stock to stay subdued, compared to peers, till clear visibility emerges in the uptick in financial performance. Hence, we downgrade the rating to Neutral, with a revised target price of INR170, which discounts FY16E EPS by 10x. Ashish Chopra (Ashish.Chopra@MotilalOswal.com); +91 22 3982 5424 Siddharth Vora (Siddharth.Vora@MotilalOswal.com); +91 22 3982 5585 Investors are advised to refer through disclosures made at the end of the Research Report.
1QFY15: Significant Profitability miss KPIT s 1QFY15 revenue grew 1.4% QoQ to USD115.2m, marginally below our estimate of 2.5% QoQ growth to USD116.4m. It consolidated I-Cubed numbers during the quarter. In Rupee terms, revenue was INR6897m, down 1.5% QoQ, v/s our estimate of INR6928m (-1% QoQ). USD Revenue was marginally below our estimate Source: MOSL, Company Gross profit margin declined a significant 550bp QoQ to 26.5% - a major disappointment during the quarter. This was despite SAP returning to profitability, which should be a tailwind of ~90-100bp in our view. Some of the factors contributing towards the steep decline in Gross margin are: Wage hikes were effective from April 01 and had a negative impact of 240bp on the EBITDA margin during the quarter. On a like to like basis the average wage hikes were 4%-5% onsite and 9%-11% offshore. Visa cost, impact from which will be spread out throughout the year, had 25bp impact in 1Q Rupee appreciated to INR59.87/USD v/s INR61.63 in 4QFY14. This had a negative impact of around 60bp on the EBITDA margin Due to one-time transaction and integration expenses, operationally I- Cubed had a loss, which had a 30bp impact Revenue mix during the quarter shifted in favor of onsite by 290bp, which as per our analysis had another 60bp impact. Offshore utilization decline 80bp QoQ, which would another ~30bp of margin loss. SGA declined 150bp QoQ to 14.4%, v/s our estimate of 15.8%, which cushioned a fraction of the decline in Gross Margins. Consequently, EBITDA margin during the quarter was 12.1%, down 400bp QoQ, v/s our estimate of 200bp QoQ decline to 14.1%. 22 July 2014 2
EBITDA margins declined 400bps QoQ, despite 150bp QoQ reduction in SGA Source: MOSL, Company The other income during the quarter stood at INR107.86m as against loss of INR177.09m in 4QFY14. Other income included forex gain of INR74.57m against a loss of INR239.17m in the previous quarter. PAT was INR508m, v/s INR515m in 4Q (excluding exceptional item) and well below our estimate of INR585m. Segment-wise performance: US soft, A&E driving growth Manufacturing was the fastest growing vertical during the quarter by 5.9% QoQ, while others decline 9.5% QoQ. Manufacturing only vertical to drive growth Verticals Contr. to Rev. Growth - QoQ Contr to incr. 4 Qtr CQGR (%) (%) rev (%) (%) Automotive & Transportation 32.7 0.0 0.0 (0.6) Manufacturing 40.9 5.9 162.6 2.3 Energy & Utilities 17.8 0.2 2.1 7.4 Others 8.6 (9.5) (64.8) (4.1) IES and A&E grew by 4.64% and 2.72% respectively while SAP and BTU declined by 3.44% and 2.69% respectively. Auto & Engineering, which is 26% of KPIT s revenues, is the healthiest of its segments over the last 4 quarters (4.2% CQGR). IES and Auto & Engg have been the growth driver over last few quarters Lines of Business Contr. to Contr Growth - QoQ (%) Rev. (%) to incr. rev (%) 4 Qtr CQGR (%) IES 40.4 4.6 129.2 2.7 Auto & Engg 26.3 2.7 49.7 4.2 SAP 22.6 (3.4) (57.7) (2.1) BTU 10.7 (2.7) (21.2) (1.0) On a QoQ basis, Europe growth was 10.96%, while US marginally grew by 0.4%. During the quarter APAC had a marginal de-growth of 3.06% due to quarterly fluctuations in billing. Over the last 6 quarters, US, the key geography, has remained flattish (between USD79-82m), hurting the overall company s growth 22 July 2014 3
(US is 69% of revenues). Europe and APAC are seeing strong traction on a low base. Europe showed healthy growth Geographies Contr. to Rev. (%) Growth - QoQ (%) Contr to incr. rev (%) 4 Qtr CQGR (%) America 69.1 0.4 21.5 (0.6) Europe 15.8 10.9 112.4 6.3 APAC 15.1 (3.0) (33.9) 7.6 Top account Cummins grew sequentially during the quarter, but revenues remain range bound (between USD18-20m). Top 2-5 clients were weak during the quarter, declining 7.2% QoQ, and have been sluggish. Top6-10 clients have been growing impressively. Top 2-5 clients segment suffered due to the second largest client. Second largest customer declined Top 2-5, to continue in next quarter Top Clients Contr. to Rev. (%) Growth - QoQ (%) Contr to incr. rev (%) 4 Qtr CQGR (%) Top Client - Cummins 15.9 3.6 0.4 0.1 Top 2-5 Clients 18.5 (7.2) (1.0) (2.7) Top 6-10 Clients 10.7 8.1 0.6 6.8 Cummins revenue grew after a sharp decline last quarter SAP showed a decline but was margin positive Source: MOSL, Company Source: MOSL, Company Takeaways from management comments Revenue growth outlook: KPIT closed multiple deals during the quarter and the execution on these has started in the month of July. It also started delivering on the telematics deal in India and expects a good ramp up in delivery during the coming quarters. The company remains positive on the growth prospects during the remainder of the year Profitability outlook: Some corrections and promotions will additionally take effect from July 01 and October 01. The net impact on operational margins due to this would be around 0.5% in both 2QFY15 and 3QFY15. The visa cost impact will be spread out throughout the year. Despite the two factors, KPIT expects sustained improvement in the operational profitability in the coming quarters aided by growth, utilization improvement and pyramid improvement. Organization restructuring: 1QFY15 is the first complete quarter post our organizational restructuring and formation of new business units. The company 22 July 2014 4
has almost completed the desired changes in our organization structure. It has filled up some new strategic positions by hiring senior level industry partisans. Cutting estimates on revenue and margins KPIT targeted EBITDA margin of 17% in FY15, however, 1QFY15 EBITDA margin of 12% implies that despite significant recovery in the remainder of the year (we model exit EBITDA margin of 16.1%), it may fall short of its target. So, our EBITDA margin is revised downwards by 110bp to 14.8% in FY15 and by 60bp to 15.9% in FY16. 1QFY15 revenues require KPIT to post a CQGR of 5.2% over 2Q-4QFY15, to meet the lower end of its guided band of 12-14%. Our earlier growth estimate of 15% factored the revenues from the acquisition as well. However, we have now moderated our revenue growth estimate to 12% in FY15 including I-Cubed. Consequently, our EPS estimates are lower by 8% for FY15 to INR13.5 and 5.9% for FY16 to INR17.1. Change in estimates Revised Earlier Change FY15E FY16E FY15E FY16E FY15E FY16E INR/USD 59.2 58.0 59.1 58.0 0.1% 0.0% USD Revenue (m) 498.0 577.7 508.0 592.2-2.0% -2.4% USD revenue growth (%) 12.1 16.0 14.3 16.6-220bp -60bp EBITDA Margin (%) 14.8 15.9 15.9 16.5-110bp -60bp EPS (INR) 13.5 17.1 14.7 18.2-8.0% -5.9% EPS Growth (%) 7.5 27.0 16.9 24.1 Valuation View KPIT remains focused on select verticals, evidenced as the company added strong ERP capabilities to its Engineering prowess by acquisitions of CPG, Sparta and Systime. Going forward, it is looking to expand to new-age services like Analytics, PLM and even IMS. Its focus on Auto engineering services should also serve it well in its quest to expand to USD1b in revenues in a few years time. However, after a sub-par FY14, 1QFY15 performance poses significant challenges to the company to converge the performance gap with peers over the medium term. This, especially in a robust demand outlook for IT Services will weigh on the company s valuation relative to peers. KPIT trades at 12.9x FY15E and 10.2x FY16E EPS. We expect the company to grow its USD revenues at a CAGR of 14% (supported by I-Cubed) over FY14-16E and EPS at a CAGR of 17% (on a forex-hit FY14 base) during this period. In congruence with the performance, we expect to stock, too, to stay subdued compared to peers; till clear visibility emerges in the uptick in financial performance. As a result, we downgrade our rating to Neutral, with a revised target of INR170, which discounts FY16E EPS by 10x. Other result highlights Total development team at the end of the quarter increased by 174 to 8,757. Offshore utilization during the quarter was 70.15%, down 80bp QoQ. 22 July 2014 5
KPIT added 3 new clients during the quarter taking total active client count to 201. Total amount of USD hedges at the end of the quarter stand at USD45.2m. These hedges are maturing in FY15 and average rate for these hedges is INR62.7 The Cash Balance as at the end of the quarter stood at INR 4.11b as compared to INR3.74b in the previous quarter. Total debt decreased to INR5.29b from INR4.94b at the end of previous quarter. Debtor days at the end of the quarter reduced by 5 days to 82 (from 87 in the previous quarter). Revenue proportion from Fixed Price contracts increased 130bps QoQ to 28.4% 22 July 2014 6
Story in Charts Offerings focused on select verticals, with mix of IT and Engg Auto Engg to be the key growth driver SAP drag FY14 performance, to return to growth in FY15 SAP turnaround drives positive revenue outlook and outlook of healthy profit growth Unlikelihood of large acquisitions to help improve FCF 22 July 2014 7
Operating Metrics 1QFY13 2QFY13 3QFY13 4QFY13 1QFY14 2QFY14 3QFY14 4QFY14 1QFY15 Geography Analysis (%) USA 76.2 76.6 75.1 75.1 75 71.9 72.7 69.8 69.1 Europe 13.7 12.6 13.6 12.8 13.1 13.8 15.4 14.5 15.8 ROW 10.1 10.9 11.3 12.1 11.9 14.5 12 15.8 15.1 LOB Analysis (%) Integrated Enterprise Solutions 32.9 34.3 35.6 36.7 39.5 39.5 40.5 40.3 40.4 Auto & Engg 23.7 24.4 23.4 25 23.6 24.2 25.3 25.8 26.3 SAP 33.3 31 29.2 27.2 26 25.3 23.7 23.9 22.6 Business Transformation Unit 10.1 10.3 11.9 11.1 10.8 11 10.6 10.1 10.7 Customer Details No. of Customers Added 3 4 2 5 6 3 3 3 3 No. of Active Customers 172 176 178 183 189 192 195 198 201 Customers with a runrate of > $1m 65 69 72 78 78 78 78 80 83 Top Customer Cummins (%) 20.6 19.7 19.1 16.6 16.8 16.5 17.9 15.5 15.9 Top 5 Customers (%) 36.3 35.2 36.8 35.2 38.6 38 38.2 35.7 34.3 Top 10 Customer (%) 44 43.7 45.2 44 47.3 46.3 47.6 45.8 45.1 Revenue Split (%) Onsite Revenues 52.7 53.8 54.7 53.8 54.2 54.6 52.8 54.3 57.2 Offshore Revenues 47.3 46.2 45.3 46.2 45.8 45.4 47.2 45.7 42.8 Contract Type (%) T&M 72 72.7 70.1 72.7 76.9 76.4 75.6 72.9 71.6 FP 28.1 27.3 29.9 27.3 23.2 23.6 24.4 27.1 28.4 Debtor Days 75 75 70 75 77 75 76 87 82 HR - Details Development Team Onsite (Avg) 1,031 1,126 1,148 1,139 1,176 1,243 1,274 1,366 1,423 Offshore (Avg) 6,074 6,207 6,364 6,486 6,553 6,708 6,987 7,139 7,224 Onsite FTE 977 1,064 1,066 1,074 1,107 1,148 1,123 1,231 1,293 Offshore FTE 4,501 4,638 4,637 4,805 4,809 4,888 4,985 5,064 5,068 Total FTE 5,478 5,702 5,703 5,879 5,916 6,036 6,108 6,295 6,361 Development 7,218 7,447 7,616 7,648 7,771 8,122 8,430 8,583 8,757 Support 530 536 538 538 545 548 554 558 568 Marketing 125 128 132 135 140 146 152 155 165 Total 7,873 8,111 8,286 8,321 8,456 8,816 9,136 9,296 9,490 Utilization (%) Onsite 94.7 94.5 92.8 94.3 94.2 92.4 88.1 90.1 90.8 Offshore (Incl. Trainees) 74.1 74.7 72.9 74.1 73.4 72.9 71.3 70.9 70.2 22 July 2014 8
: an investment profile Company description KPIT Cummins is a leading technology solutions partner for global manufacturing corporations, with special focus on automotive, energy & utilities, industrial equipments and semiconductor industries. With over USD450m revenue (LTM) and 9,490 employees, company continues to focus on its chosen areas to grow, with equal thrust on organic and inorganic approaches. Key investment arguments A rare example in Indian IT of successfully integrating multiple acquisitions. Impressive organic growth despite inorganic thrust - 39.5% in FY11 and 37% in FY12. Potential option value from success of its hybrid engine venture Revolo. Key investment risks Continued pressure on profit margins due to lower margin profile of acquisitions. Limited free cash flow generation due to thrust on inorganic growth route. Recent developments To enhance the existing IMS portfolio KPIT have formed a partnership with HP for cloud services and have launched KPIT Cloud powered by HP. KPIT added 3 new customers during the quarter. Valuation and view We expect KPIT to post revenue at a CAGR of 14% and EPS CAGR of 17% over FY14-16. The stock trades at 12.9x FY15E and 10.2x FY16E EPS. Downgrade to Neutral with a target price of INR170, which discounts our FY16E EPS by 10x. Sector view With strengthening demand in the US and large deals traction in traditional services in Europe, industry growth in FY15 should be better than FY14. Digital technologies/smac may not be a needle mover right now but are increasingly seeing traction and can potentially drive downstream opportunity. We see better risk-reward in Tier-I v/s Tier-II. Currency is a key risk to valuations, and Tier-II has a higher sensitivity to the same v/s Tier-I. Comparative valuations KPIT MTCL HEXW P/E (x) FY15E 13.2 15.1 14.6 FY16E 10.4 12.4 12.1 P/BV (x) FY15E 2.3 3.9 3.5 FY16E 1.9 3.1 3.2 EV/Sales (x) FY15E 1.1 2.0 1.6 FY16E 0.9 1.6 1.4 EV/EBITDA (x) FY15E 7.3 9.7 9.1 FY16E 5.1 7.8 7.9 EPS: MOSL forecast v/s consensus (INR) MOSL Forecast Consensus Forecast Variation (%) FY15 13.5 15.7-13.7 FY16 17.1 18.2-6.2 Target price and recommendation Current Target Upside Reco Price (INR) Price (INR) (%) 172 170-2.7 Neutral Shareholding pattern (%) Mar-14 Dec-13 Mar-13 Promoter 22.3 22.5 24.3 DII 6.9 7.0 11.8 FII 33.0 42.0 30.8 Others 37.8 28.5 33.1 Note: FII Includes depository receipts Stock performance (1-year) 22 July 2014 9
Financials and valuation 22 July 2014 10
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