CMP* (Rs) 194 Market Cap. (Rs bn) 20 Free Float (%) 69 Shares O/S (mn) 105 Sonata Software Unimpressive Show; IITS Revenue Disappoints Sonata Software (Sonata) delivered an unimpressive performance in 3QFY17, with IITS business revenue declining 2.9% QoQ to $30.3mn (~4% below our estimate). However, IITS revenue adjusting for Systems Integration (hardware) revenue in 2QFY17 rose 1% QoQ in USD terms and 3.5% QoQ in CC terms. DPS revenue rose by 31% QoQ and 20.9% YoY to Rs4.15bn. While consolidated EBIT margin topped our estimate by 32bps due to higher IITS margin led by o-shoring and lower SI revenue, net profit rose 2.2% QoQ (-3.9% YoY) to Rs387mn (6.4% below our estimate). From vertical perspective, OPD continued to face pressure with 6% sequential decline. Steep 9.8% sequential revenue decline in Travel (key vertical for Rezopia platform) is another area of concern, and decline was owing to a client-specific issue in the UK, apart from currency pressures. Service-wise, ADM declined by a steep 10.4% QoQ, even as the IMS segment grew by 2.5% QoQ, reflecting its importance as the key growth driver. Share price (%) 1 mth 3 mth 12 mth Absolute performance (1.4) 21.3 19.5 Relative to Nifty (8.1) 17.0 2.0 Shareholding Pattern (%) Sept 16 Dec 16 Promoter 31.0 31.0 Public 69.1 69.1 1 Year Stock Price Performance 220 200 A None-too Impressive Show on All Counts Sonata witnessed pressure on its key verticals in 3QFY17. Continuing to remain volatile, revenue from OPD vertical dipped 6% QoQ, following two successive quarters of 10% QoQ growth. We had noted this risk owing to disruptive impact of SMAC in our initiating report on Sonata in Dec 16. Steep 9.8% sequential revenue decline in Travel (Sonata s key focus area particularly for Rezopia platform, acquired >2 years back) is another area of concern. Sequential growth of 14% in Retail & CPG business, which is now the 2nd-largest vertical, is a key positive. This vertical has accounted for ~80% of Sonata s incremental revenue over past 8 quarters. 180 160 140 120 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Note: * CMP as on February 06, 2017 Sep-16 Oct-16 Oct-16 Nov-16 Dec-16 Jan-17 Nonetheless, Sonata s 3QFY17 show is less-than-enthusing given revenue decline in USD terms, despite management s positive commentary of healthy revenue growth. We believe EBITDA margin expansion of 94bps QoQ in IITS business is unsustainable in the absence of sustained improvement in revenue growth. Outlook & Valuation We like Sonata s dierentiated business model, high dividend yield, quality balance sheet, high RoE and no equity dilution for over 15 years. However, the stock has risen 23%, surpassing our original target price since we initiated coverage in Dec 16. We believe the stock will remain subdued in the near-term given sharp up-move in the counter and subdued performance in 3QFY17. Hence, we downgrade our recommendation on the stock to from BUY with a marginally revised Target Price of Rs190 (from Rs185 earlier), as we partially roll over to FY19E. Key Financials (Rs mn) FY15 FY16 FY17E FY18E FY19E Net Sales 16,821 19,405 24,396 28,113 31,986 EBITDA 1,676 1,919 2,010 2,408 2,932 APAT 1,337 1,586 1,542 1,813 2,163 Diluted EPS (Rs) 12.7 15.1 14.7 17.2 20.6 P/E (x) 15.2 12.8 13.2 11.2 9.4 EV / EBITDA (x) 10.9 9.1 8.7 7.2 5.9 RoE (%) 33.3 35.3 31.0 32.5 33.9 Research Analyst: Harit Shah Contact: 022 33201276 Email: harit.shah@relianceada.com 1
Key Conference Call Takeaways Adjusting for $1.2mn one-time Systems Integration (SI, hardware implementation)- related revenue in 2QFY17, adjusted revenue rose 1% QoQ in reported terms and 3.5% QoQ in CC terms. BREXIT has impacted a key Travel client in the UK, which led to the decline in Travel and European revenue, Sonata has around 60 people in the US on H1B visas, which is minimal, and a major part of its US sta consists of local US hires, owing to acquisitions made in past years, Sonata earned around $1.7mn revenue from IBIS, which was EBITDA-neutral, a positive, Management maintains its stance of revenue growth being the biggest margin lever for Sonata. Key Risks Client-specific issues in any of the top-10 clients, which could impact revenue growth Growth pangs in the OPD vertical, given the disruptive impact of SMAC, which could aect revenue growth General growth volatility given Sonata s small size Event-specific risks such as BREXIT, which could impact IT budgets, cutting discretionary spend and delaying new deals With Donald Trump as US President, the risk of noise regards oshoring taking away US jobs, higher visa costs and a more punishing visa regime abound Cannibalisation of existing revenue particularly on the ADM and ERP side by the shift to cloud architecture Currency risks Exhibit 1: Quarterly Performance (Consolidated) (Rs mn) 3QFY17 2QFY17 QoQ (%) 3QFY16 YoY (%) IITS Net Revenue ($mn) 30.3 31.2 (2.9) 27.4 10.6 Consolidated Net Revenue 6,126 5,225 17.2 5,220 17.4 Inventory Costs 3,887 3,068 26.7 3,197 21.6 Employee Costs 1,170 1,127 3.8 1,015 15.2 Other Operating Expenses 533 523 1.8 442 20.4 EBITDA 536 506 5.8 566 (5.3) Depreciation 23 22 6.0 15 50.5 EBIT 513 485 5.8 550 (6.8) Interest Cost 24 13 76.6 22 6.7 Other Income 86 83 3.3 66 30.5 PBT 575 554 3.7 594 (3.2) Tax 189 176 7.1 192 (1.6) APAT 387 378 2.2 402 (3.9) RPAT 387 378 2.2 402 (3.9) 2
Exhibit 2: Margin break-up Particulars 3QFY17 2QFY17 QoQ (bps) 3QFY16 YoY (bps) Inventory Cost % Net Revenue 63.5 58.7 474 61.2 222 Employee Cost % Net Revenue 19.1 21.6 (248) 19.5 (35) SG&A and Other Expenses % Net Revenues 8.7 10.0 (132) 8.5 22 EBITDA Margin (%) 8.7 9.7 (94) 10.8 (209) EBIT Margin (%) 8.4 9.3 (90) 10.5 (217) Tax Rate (%) 32.8 31.8 101 32.3 52 APAT Margin (%) 6.3 7.2 (93) 7.7 (140) Exhibit 3: Actuals vs RSec (3QFY17) Actuals RSec estimates % variation from RSec estimates IITS Revenue (US$ mn) 30.3 31.5 (3.8) Cons. Revenue (Rs mn) 6,126 6,595 (7.1) Cons. EBIT (Rs mn) 513 531 (3.4) Cons. EBIT margin (%) 8.4 8.0 32 bps Cons. Net profit (Rs mn) 387 413 (6.4) Source: Bloomberg Exhibit 4: Assumptions Particulars FY15 FY16 FY17E FY18E FY19E IITS USD revenue growth (%) 24.1 9.7 13.0 14.0 12.5 USD/INR rate 61.72 65.57 66.50 67.50 68.00 IITS EBITDA margin (%) 21.7 22.0 20.0 20.0 20.0 DPS EBITDA margin (%) 3.5 4.4 3.5 4.0 5.0 Cons. EBITDA margin (%) 10.0 9.9 8.2 8.6 9.2 Exhibit 5: Vertical break-up OPD 34.0 31.0 29.0 28.0 30.0 31.0 30.0 TTL 32.0 31.0 33.0 31.0 29.0 28.0 26.0 CPG & Retail 16.0 19.0 21.0 24.0 24.0 23.0 27.0 Others 18.0 19.0 17.0 17.0 17.0 18.0 17.0 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Exhibit 6: Vertical growth OPD (2.9) (8.5) (1.4) 0.4 9.8 10.4 (6.0) TTL (3.0) (2.8) 12.2 (2.3) (4.2) 3.2 (9.8) CPG & Retail 6.7 19.2 16.5 18.9 2.5 2.4 14.0 Others 5.9 6.0 (5.7) 4.0 2.5 13.1 (8.3) 3
Exhibit 7: Service line break-up ADM 26.0 26.0 24.0 23.0 25.0 26.0 24.0 Testing 19.0 19.0 18.0 18.0 15.0 16.0 17.0 AX 15.0 14.0 13.0 15.0 16.0 15.0 15.0 ERP 5.0 6.0 3.0 4.0 4.0 4.0 5.0 IMS 10.0 12.0 12.0 15.0 16.0 18.0 19.0 BI 6.0 7.0 9.0 9.0 9.0 9.0 9.0 E-commerce 9.0 9.0 10.0 9.0 7.0 6.0 6.0 Mobility* 3.0 2.0 4.0 2.0 2.0 1.0 2.0 Cloud* 4.0 3.0 4.0 2.0 1.0 1.0 Rezopia 3.0 2.0 3.0 3.0 5.0 4.0 3.0 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 ; Mobility and Cloud have been clubbed together wef. 3QFY17. Exhibit 8: Service line growth ADM (10.3) 0.4 (2.7) (0.3) 11.4 11.1 (10.4) Testing 5.6 0.4 (0.2) 4.0 (14.6) 14.0 3.2 AX 15.4 (6.3) (2.1) 20.0 9.3 0.2 (2.9) ERP 0.0 20.5 (47.3) 38.7 2.5 6.8 21.4 IMS 11.1 20.5 5.4 30.0 9.3 20.2 2.5 BI (14.3) 17.1 35.5 4.0 2.5 6.8 (2.9) E-commerce (10.0) 0.4 17.1 (6.4) (20.3) (8.4) (2.9) Mobility* 0.0 (33.1) 110.8 (48.0) 2.5 (46.6) (2.9) Cloud* 33.3 (24.7) 40.5 (48.0) (48.8) 6.8 Rezopia 0.0 (33.1) 58.1 4.0 70.8 (14.5) (27.2) ; Mobility and Cloud have been clubbed together wef. 3QFY17. Exhibit 9: Geographic break-up USA 51.0 55.0 56.0 60.0 61.0 59.0 60.0 Europe 34.0 31.0 31.0 26.0 26.0 26.0 24.0 RoW 15.0 14.0 13.0 14.0 13.0 15.0 16.0 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Exhibit 10: Geographic growth USA (1.9) 8.3 7.3 11.4 4.2 3.3 (1.2) Europe 0.0 (8.5) 5.4 (12.8) 2.5 6.8 (10.4) RoW 7.1 (6.3) (2.1) 12.0 (4.9) 23.3 3.6 4
Exhibit 11: Onsite-oshore contribution Onsite 34.0 38.0 42.0 43.0 42.0 45.0 40.0 Oshore 66.0 62.0 58.0 57.0 58.0 55.0 60.0 Exhibit 12: Onsite-oshore growth Onsite 3.0 12.2 16.5 6.5 0.1 14.5 (13.7) Oshore (1.5) (5.7) (1.4) 2.2 4.3 1.3 5.9 Exhibit 13: Client contribution Top-10 72.0 73.0 72.0 67.0 70.0 71.0 70.0 Non-top 10 28.0 27.0 28.0 33.0 30.0 29.0 30.0 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Exhibit 14: Client growth Top-10 0.0 1.8 3.9 (3.2) 7.0 8.4 (4.3) Non-top 10 0.0 (3.2) 9.3 22.6 (6.9) 3.3 0.5 5
Profit and Loss Statement Y/E Mar (Rs mn) FY15 FY16 FY17E FY18E FY19E Net Sales 16,821 19,405 24,396 28,113 31,986 Growth (%) 7.4 15.4 25.7 15.2 13.8 Total Operating Expenses 15,145 17,486 22,386 25,704 29,055 EBITDA 1,676 1,919 2,010 2,408 2,932 EBITDA (%) 10.0 9.9 8.2 8.6 9.2 EBITDA Growth (%) 68.5 14.5 4.7 19.8 21.7 Depreciation 61 62 92 104 115 EBIT 1,616 1,857 1,918 2,305 2,817 EBIT (%) 9.6 9.6 7.9 8.2 8.8 EBIT Growth (%) 76.5 15.0 3.2 20.2 22.2 Other Income 199 438 457 478 501 Interest 28 79 171 154 137 PBT 1,787 2,216 2,203 2,628 3,181 Tax (incl deferred) 486 667 661 815 1,018 Minority Interest (4) 0 0 0 0 Exceptional Items 32 37 0 0 0 PAT 1,337 1,586 1,542 1,813 2,163 PAT Growth (%) 71.9 18.6 (2.8) 17.6 19.3 EPS 12.7 15.1 14.7 17.2 20.6 EPS Growth (%) 71.9 18.6 (2.8) 17.6 19.3 Balance Sheet Y/E Mar (Rs mn) FY15 FY16 FY17E FY18E FY19E SOURCES OF FUNDS Share Capital - Equity 105 105 105 105 105 Reserves 4,179 4,605 5,137 5,815 6,716 Total Shareholders' Funds 4,284 4,710 5,243 5,920 6,821 Total Debt 244 1,713 1,713 1,713 1,713 Long Term Provisions & Others 20 162 162 162 162 Creditors 2,496 2,655 3,373 3,873 4,378 Other Current Liabilities & Provns 1,037 680 750 797 845 Total Current Liabilities 3,533 3,334 4,123 4,670 5,223 TOTAL SOURCES OF FUNDS 8,081 9,919 11,240 12,465 13,918 APPLICATION OF FUNDS Goodwill & Other Intan. Assets 111 935 935 935 935 Net Block 123 250 402 579 784 CWIP 2 16 16 16 16 Deferred Tax Assets 89 129 129 129 129 LT Loans & Advances, Others 928 658 658 658 658 Total Non Current Assets 1,252 1,989 2,141 2,318 2,523 Inventories 73 100 100 100 100 Debtors 3,271 3,755 5,013 6,008 7,098 Cash & Bank 1,998 2,953 2,864 2,917 3,075 Liquid Investments 639 522 522 522 522 Other Current Assets 848 599 599 599 599 Total Current Assets 6,829 7,930 9,099 10,146 11,395 TOTAL APPLI. OF FUNDS 8,081 9,919 11,240 12,465 13,918 6
Cash Flow Statement Y/E Mar (Rs mn) FY15 FY16 FY17E FY18E FY19E PAT 1,337 1,586 1,542 1,813 2,163 Non-operating & EO items 4 0 0 0 0 Depreciation 61 62 92 104 115 Working Capital Change (663) 512 (469) (448) (538) Cash Flow from Operations (a) 739 2,159 1,165 1,470 1,740 Capex (113) (258) (244) (281) (320) Investments 26 0 0 0 0 Cash Flow from Investing (b) (87) (258) (244) (281) (320) Debt Issuance/(Repaid) 187 187 0 0 0 Dividend (675) (1,676) (1,010) (1,136) (1,262) Cash Flow from Financing (c) (488) (1,489) (1,010) (1,136) (1,262) NET CASH FLOW (a+b+c) 164 412 (88) 53 158 EO items, others (31) 542 0 0 0 Closing Cash Balance 1,998 2,953 2,864 2,917 3,075 Free Cash Flow 626 1,902 921 1,188 1,420 Key Ratios Y/E Mar FY15 FY16 FY17E FY18E FY19E Profitability (%) EBITDA Margin 10.0 9.9 8.2 8.6 9.2 APAT Margin 7.9 8.2 6.3 6.5 6.8 RoE 33.3 35.3 31.0 32.5 33.9 RoIC or Core RoCE 20.9 17.8 17.3 17.5 18.3 RoCE 29.3 28.9 27.0 28.5 30.1 Eiciency Tax Rate (%) 27.2 30.1 30.0 31.0 32.0 Fixed Asset Turnover (x) 20.1 18.1 18.6 17.6 16.7 Inventory (days) 2 2 1 1 1 Debtors (days) 71 71 75 78 81 Payables (days) 60 55 55 55 55 Cash Conversion Cycle (days) 12 17 21 24 27 Net Debt/EBITDA (x) (0.6) (0.9) (0.8) (1.4) (1.2) Net Debt/Equity (x) (0.2) (0.4) (0.3) (0.6) (0.5) Interest Coverage (x) 58.6 23.4 11.2 15.0 20.6 Per Share Data (Rs) EPS 12.7 15.1 14.7 17.2 20.6 CEPS 13.3 15.7 15.5 18.2 21.7 DPS 7.0 9.0 8.0 9.0 10.0 BV 40.7 44.8 49.9 56.3 64.9 Valuation P/E 15.2 12.8 13.2 11.2 9.4 P/BV 4.8 4.3 3.9 3.4 3.0 EV/EBITDA 10.9 9.1 8.7 7.2 5.9 OCF/EV (%) 4.0 12.4 6.7 8.4 10.1 FCF/EV (%) 3.4 10.9 5.3 6.8 8.2 FCFE/mkt cap (%) 3.1 9.3 4.5 5.8 7.0 Dividend Yield (%) 3.6 4.6 4.1 4.6 5.2 7
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