3QFY18 Result Update February 08, 2018 CMP* (Rs) 289 Market Cap. (Rs bn) 30 Free Float (%) 69 Shares O/S (mn) 105 IITS Revenue Continues to Remain Buoyant; Margin Growth Heartening In-line with our estimate, s USD revenue from IITS business rose by a decent 2.7% QoQ in 3QFY18 to US$37.4mn. Staging a comeback to normal level, DPS revenue surged by 165.5% QoQ to Rs5.3bn (on a lower sequential base), as the segmental revenue was impacted in 2QFY18 due to a change in go-to-market strategy of some key principals. Consolidated revenue surged by ~80% QoQ, while consolidated EBITDA margin declined by 434bps QoQ owing to a higher contribution of DPS business to revenue. However, IITS margin grew by a strong 317bps QoQ led by a higher proportion of IP revenue and lower sta cost owing to a reduction in employee base led by completion of a temporary project. Consolidated EBIT margin declined by 399bps QoQ, while adjusted net profit rose by 9.2% QoQ to Rs493mn. Share price (%) 1 mth 3 mth 12 mth Absolute performance 2.0 52.6 51.3 Relative to Nifty 2.6 50.0 30.8 Shareholding Pattern (%) Sep'17 Dec'17 Promoter 31.0 31.0 Public 69.1 69.1 From vertical perspective, following two successive quarters of growth, OPD revenue declined by 0.8%. On a positive note, Sonata won some new clients towards 3QFY18-end, ramp-ups for which should start reflecting by 1QFY19E. Aided by Sonata s focus on platforms, Travel and CPG & Retail verticals clocked strong revenue growth of 6.6% and 6.7% QoQ, respectively. Service-wise, Testing and Microsoft AX were the key growth drivers, which grew by 8.5% QoQ and 8.2% QoQ, respectively. Notably, AX being the 2nd largest service after ADM (with 20% revenue contribution), higher revenue reflects Sonata s strong relationship with Microsoft. Geowise, growth was evenly spread across geographies, with the US, Europe and Rest of the World clocking 2.7% QoQ growth each. IP Revenue Drives Growth & Margin Following two successive quarters of strong growth, Sonata delivered another good quarter in IITS revenue, which rose by 2.7% QoQ in USD terms. This growth comes on top of 11.3% QoQ and 6.5% QoQ growth in 2QFY18 and 1QFY18, respectively. On YoY basis, IITS revenue (in USD terms) rose by a strong 23.4% marking the fastest growth since 2QFY15 led by focus on platforms and IP-led solutions (platformation). Focus on consumer-centric verticals which require high investment in digital initiatives continues to remain the key tailwind. Notably, 15.2% of Sonata s 3QFY18 revenue was IP-led (vs. 15% in 2QFY18 and 14% in 1QFY18). We expect focus on its platformation strategy to drive growth and profitability, going forward. 1 Year Stock Price Performance 320 280 240 200 160 120 Feb-17 Mar-17 Apr-17 May-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Note: * CMP as on Feb. 08, 2018 Nov-17 Dec-17 Jan-18 Feb-18 Outlook & Valuation We like Sonata s dierentiated business, high dividend yield, quality balance sheet, high RoE and lack of equity dilution in last 17 years. Notwithstanding sharp run-up in stock price in last couple of months, we envisage enough legroom for further upside on the back of Sonata s platform focus, investments made in IP and S&M, decent cash generation and reasonable valuation coupled with healthy growth (18.3% EPS CAGR over FY17-FY20E). We raise our EPS estimates 4-6% for FY18E and FY19E. Upgrading our PE multiple to 14x from 12x on higher growth, we maintain our recommendation on the stock with a revised Target Price of Rs340 (from Rs234 earlier). Key Financials (Rs mn) FY17 FY18E FY19E FY20E Net Sales 25,211 26,586 29,948 33,495 EBITDA 1,923 2,272 2,773 3,421 APAT 1,537 1,880 2,134 2,546 Diluted EPS (Rs) 14.6 17.9 20.3 24.2 P/E (x) 19.8 16.2 14.2 11.9 Research Analyst: Harit Shah Contact: 022 33201276 Email: harit.shah@relianceada.com EV / EBITDA (x) 14.5 12.1 9.7 7.6 RoE (%) 31.2 34.0 33.7 34.4 1
Conference Call Key Highlights Headcount in IITS business declined by ~5% QoQ owing to completion of a critical project of a strategic client, as these employees were temp hires. Staging a comeback to normal levels, DPS revenue surged substantially albeit on a lower sequential base, as revenue was impacted in 2QFY18 due to a change in go-tomarket strategy of some key principals. The Management expects the OPD business to start showing growth, as it has won new clients in this business towards 3QFY18-end, which should start ramping up from 1QFY19E onward. Sonata earned ~$2.4mn revenue (+3% QoQ) from IBIS, while it earned 14-15% EBITDA margin (vs. 11% in 2QFY18 and just 5% in 1QFY18), reflecting improving performance. The Management expects a marginal benefit of the US Tax Code. Key Risks Client-specific issues in any of the Top-10 clients could impact revenue growth. Growth pangs in OPD vertical, given the disruptive impact of SMAC, could aect revenue growth. Cost escalation could impact project delivery and margins. Cannibalisation of existing revenue particularly on ADM and ERP side following strategic shift to Cloud architecture. Currency risk. Exhibit 1: Quarterly Performance (Consolidated) Particulars (Rs mn) 3QFY18 2QFY18 QoQ (%) 3QFY17 YoY (%) IITS Net Revenue (US$ mn) 37.4 36.4 2.7 30.3 23.4 Consolidated Net Revenue 7,667 4,269 79.6 5,751 33.3 Inventory Costs 5,171 1,873 176.0 3,512 47.2 Employee Costs 1,312 1,321 (0.7) 1,157 13.4 Other Operating Expenses 535 527 1.3 534 0.1 EBITDA 651 547 18.9 548 18.7 Depreciation 31 32 (3.1) 27 16.2 EBIT 619 515 20.3 521 18.9 Interest Cost 9 12 (26.4) 24 (62.8) Other Income 65 112 (41.9) 102 (36.1) PBT 675 615 9.9 599 12.8 Tax 182 163 11.7 194 (6.3) Minority Interest 0 0 1 APAT 493 451 9.2 403 22.3 E/o (adj for tax) - 2 - RPAT 493 453 8.8 403 22.3 2
Exhibit 2: Margin Break Up Particulars 3QFY18 2QFY18 QoQ (bps) 3QFY17 YoY (bps) Inventory Cost % Net Revenue 67.4 43.9 2,355 61.1 636 Employee Cost % Net Revenue 17.1 30.9 (1,383) 20.1 (301) SG&A and Other Exp. % Net Revenues 7.0 12.4 (538) 9.3 (231) EBITDA Margin (%) 8.5 12.8 (434) 9.5 (104) EBIT Margin (%) 8.1 12.1 (399) 9.1 (98) Tax Rate (%) 27.0 26.5 44 32.5 (550) APAT Margin (%) 6.4 10.6 (414) 7.0 (58) Exhibit 3: Key Assumptions Particulars FY17 FY18E FY19E FY20E IITS USD revenue growth (%) 12.6 20.0 17.5 15.0 USD/INR rate 67.17 65.00 65.00 65.00 IITS EBITDA margin (%) 17.7 18.0 18.5 19.0 DPS EBITDA margin (%) 2.9 3.5 4.0 5.0 Cons. EBITDA margin (%) 7.6 8.5 9.3 10.2 Exhibit 4: Vertical break-up OPD 30.0 31.0 30.0 29.0 30.0 29.0 28.0 TTL 29.0 28.0 26.0 27.0 28.0 27.0 28.0 CPG & Retail 24.0 23.0 27.0 26.0 24.0 26.0 27.0 Others 17.0 18.0 17.0 18.0 18.0 18.0 17.0 Exhibit 5: Vertical growth OPD 9.8 10.4 (6.0) (2.1) 10.2 7.6 (0.8) TTL (4.2) 3.2 (9.8) 5.2 10.5 7.3 6.6 CPG & Retail 2.5 2.4 14.0 (2.4) (1.7) 20.6 6.7 Others 2.5 13.1 (8.3) 7.3 6.5 11.3 (3.0) 3
Exhibit 6: Service line break-up ADM 25.0 26.0 24.0 25.0 23.0 23.0 23.0 Testing 15.0 16.0 17.0 17.0 19.0 18.0 19.0 AX 16.0 15.0 15.0 15.0 17.0 19.0 20.0 ERP 4.0 4.0 5.0 5.0 5.0 5.0 4.0 IMS 16.0 18.0 19.0 19.0 18.0 17.0 17.0 BI 9.0 9.0 9.0 8.0 8.0 7.0 8.0 E-commerce 7.0 6.0 6.0 6.0 5.0 6.0 5.0 Mobility* 2.0 1.0 2.0 1.0 1.0 5.0 4.0 Cloud 1.0 1.0 Rezopia 5.0 4.0 3.0 4.0 4.0 ; Mobility and Cloud have been clubbed together wef. 3QFY17, and Rezopia has also been included as part of Mobility wef. 2QFY18. Exhibit 7: Service line growth ADM 11.4 11.1 (10.4) 5.5 (2.0) 11.3 2.7 Testing (14.6) 14.0 3.2 1.3 19.0 5.5 8.5 AX 9.3 0.2 (2.9) 1.3 20.7 24.4 8.2 ERP 2.5 6.8 21.4 1.3 6.5 11.3 (17.8) IMS 9.3 20.2 2.5 1.3 0.9 5.1 2.7 BI 2.5 6.8 (2.9) (9.9) 6.5 (2.6) 17.4 E-commerce (20.3) (8.4) (2.9) 1.3 (11.2) 33.6 (14.4) Mobility* 2.5 (46.6) (2.9) (49.3) 6.5 11.3 (17.8) Cloud (48.8) 6.8 Rezopia 70.8 (14.5) (27.2) 35.1 6.5 ; Mobility and Cloud have been clubbed together wef. 3QFY17, and Rezopia has also been included as part of Mobility wef. 2QFY18. Exhibit 8: Geographic break-up USA 61.0 59.0 60.0 60.0 60.0 59.0 59.0 Europe 26.0 26.0 24.0 24.0 26.0 27.0 27.0 RoW 13.0 15.0 16.0 16.0 14.0 14.0 14.0 Exhibit 9: Geographic growth USA 4.2 3.3 (1.2) 1.3 6.5 9.5 2.7 Europe 2.5 6.8 (10.4) 1.3 15.4 15.6 2.7 RoW (4.9) 23.3 3.6 1.3 (6.8) 11.3 2.7 4
Exhibit 10: Onsite-oshore contribution Onsite 42.0 45.0 40.0 43.0 43.0 45.0 45.0 Oshore 58.0 55.0 60.0 57.0 57.0 55.0 55.0 Exhibit 11: Onsite-oshore growth Onsite 0.1 14.5 (13.7) 8.9 6.5 16.5 2.7 Oshore 4.3 1.3 5.9 (3.7) 6.5 7.4 2.7 Exhibit 12: Client contribution Top-5 58.0 60.0 59.0 59.0 61.0 60.0 62.0 Clients 6-10 12.0 11.0 11.0 11.0 9.0 9.0 9.0 Top-10 70.0 71.0 70.0 70.0 70.0 69.0 71.0 Clients 11-20 6.0 7.0 10.0 11.0 9.0 9.0 8.0 Top-20 76.0 78.0 80.0 81.0 79.0 78.0 79.0 Non top-20 24.0 22.0 20.0 19.0 21.0 22.0 21.0 ; From 4QFY16, Sonata started giving out top-5 and top-20 client data. Exhibit 13: Client growth Top-5 2.5 10.5 (4.5) 1.3 10.1 9.5 6.2 Clients 6-10 36.6 (2.1) (2.9) 1.3 (12.9) 11.3 2.7 Top-10 7.0 8.4 (4.3) 1.3 6.5 9.7 5.7 Clients 11-20 (52.7) 24.7 38.7 11.5 (12.9) 11.3 (8.7) Top-20 (2.7) 9.7 (0.4) 2.6 3.9 9.9 4.1 Non top-20 22.9 (2.1) (11.7) (3.7) 17.7 16.6 (1.9) ; From 4QFY16, Sonata started giving out top-5 and top-20 client data. 5
Profit and Loss Statement Y/E March (Rs mn) FY17 FY18E FY19E FY20E Net Sales 25,211 26,586 29,948 33,495 Growth (%) 29.9 5.5 12.6 11.8 Total Operating Expenses 23,289 24,313 27,175 30,074 EBITDA 1,923 2,272 2,773 3,421 EBITDA (%) 7.6 8.5 9.3 10.2 EBITDA Growth (%) 0.2 18.2 22.1 23.4 Depreciation 93 130 149 167 EBIT 1,830 2,142 2,625 3,254 EBIT (%) 7.3 8.1 8.8 9.7 EBIT Growth (%) (1.5) 17.1 22.6 24.0 Other Income 403 631 554 580 Interest 91 49 41 34 PBT 2,142 2,724 3,138 3,800 Tax (incl deferred) 682 844 1,004 1,254 Minority Interest 0 0 0 0 Exceptional Items 77 0 0 0 PAT 1,537 1,880 2,134 2,546 PAT Growth (%) (3.1) 22.3 13.5 19.3 EPS (Rs) 14.6 17.9 20.3 24.2 EPS Growth (%) (3.1) 22.3 13.5 19.3 Balance Sheet Y/E March (Rs mn) FY17 FY18E FY19E FY20E SOURCES OF FUNDS Share Capital - Equity 105 105 105 105 Reserves 5,045 5,788 6,660 7,944 Total Shareholders' Funds 5,150 5,894 6,765 8,049 Total Debt 343 311 278 245 Long Term Provisions & Others 187 187 187 187 Creditors 4,482 4,796 5,584 6,344 Other Current Liabilities & Provns 1,791 1,837 1,965 2,094 Total Current Liabilities 6,274 6,633 7,549 8,439 TOTAL SOURCES OF FUNDS 11,953 13,024 14,779 16,920 APPLICATION OF FUNDS Goodwill & Other Intangible Assets 909 909 909 909 Net Block 270 406 557 725 CWIP 16 16 16 16 Deferred Tax Assets 127 127 127 127 LT Loans & Advances, Others 801 801 801 801 Total Non Current Assets 2,124 2,260 2,411 2,579 Debtors 5,443 5,973 6,974 8,075 Cash & Bank 2,477 2,883 3,486 4,358 Liquid Investments 1,178 1,178 1,178 1,178 Other Current Assets 730 730 730 730 Total Current Assets 9,829 10,764 12,368 14,342 TOTAL APPLICATION OF FUNDS 11,953 13,024 14,779 16,920 6
Cash Flow Statement Y/E March (Rs mn) FY17 FY18E FY19E FY20E PAT 1,537 1,880 2,134 2,546 Depreciation 93 130 149 167 Working Capital Change 1,120 (170) (86) (211) Cash Flow from Operations (a) 2,751 1,840 2,196 2,501 Capex (113) (266) (299) (335) Investments (0) 0 0 0 Cash Flow from Investing (b) (113) (266) (299) (335) Debt Issuance/(Repaid) (1,370) (33) (33) (33) Dividend (694) (1,136) (1,262) (1,262) Cash Flow from Financing (c) (2,064) (1,168) (1,294) (1,294) NET CASH FLOW (a+b+c) 573 406 603 872 EO items, others (1,049) 0 0 0 Closing Cash Balance 2,477 2,883 3,486 4,358 Free Cash Flow 2,637 1,574 1,897 2,166 Key Ratios Y/E March (Rs mn) FY17 FY18E FY19E FY20E Profitability (%) EBITDA Margin 7.6 8.5 9.3 10.2 APAT Margin 6.1 7.1 7.1 7.6 RoE 31.2 34.0 33.7 34.4 RoIC or Core RoCE 14.7 15.8 16.7 17.8 RoCE 25.3 26.8 28.2 29.4 Eiciency Tax Rate (%) 31.8 31.0 32.0 33.0 Fixed Asset Turnover (x) 21.3 18.3 17.1 16.1 Inventory (days) 0 0 0 0 Debtors (days) 79 82 85 88 Payables (days) 70 72 75 77 Cash Conversion Cycle (days) 9 10 10 11 Net Debt/EBITDA (x) (1.8) (1.8) (1.7) (1.6) Net Debt/Equity (x) (0.7) (0.7) (0.7) (0.7) Interest Coverage (x) 20.2 43.7 63.7 95.6 Per Share Data (Rs) EPS 14.6 17.9 20.3 24.2 CEPS 15.5 19.1 21.7 25.8 DPS 5.5 9.0 10.0 10.0 BV 49.0 56.0 64.3 76.5 Valuation P/E 19.8 16.2 14.2 11.9 P/BV 5.9 5.2 4.5 3.8 EV/EBITDA 14.5 12.1 9.7 7.6 OCF/EV (%) 9.9 6.7 8.2 9.6 FCF/EV (%) 9.5 5.7 7.1 8.3 FCFE/mkt cap (%) 8.7 5.2 6.2 7.1 Dividend Yield (%) 1.9 3.1 3.5 3.5 7
Rating Guides Rating Expected absolute returns (%) over 12 months >10% HOLD -5% to 10% REDUCE >-5% Reliance Securities Limited (RSL), the broking arm of Reliance Capital is one of the India s leading retail broking houses. Reliance Capital is amongst India s leading and most valuable financial services companies in the private sector. Reliance Capital has interests in asset management and mutual funds, life and general insurance, commercial finance, equities and commodities broking, wealth management services, distribution of financial products, private equity, asset reconstruction, proprietary investments and other activities in financial services. The list of associates of RSL is available on the website www.reliancecapital.co.in. RSL is registered as a Research Analyst under SEBI (Research Analyst) Regulations, 2014 General Disclaimers: This Research Report (hereinafter called Report ) is prepared and distributed by RSL for information purposes only. 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