Margin beat driven by Headcount reduction November 01, 2017 Madhu Babu madhubabu@plindia.com +91 22 66322300 Rating BUY Price Rs489 Target Price Rs535 Implied Upside 9.4% Sensex 33,600 Nifty 10,441 (Prices as on November 01, 2017) Trading data Market Cap. (Rs bn) 470.9 Shares o/s (m) 963.0 3M Avg. Daily value (Rs m) 1056.9 Major shareholders Promoters 36.41% Foreign 36.32% Domestic Inst. 13.93% Public & Other 13.34% Stock Performance (%) 1M 6M 12M Absolute 6.9 17.3 12.8 Relative (0.5) 5.0 (7.7) How we differ from Consensus EPS (Rs) PL Cons. % Diff. 2018 38.1 33.8 12.7 2019 39.3 36.7 7.1 Price Perf. (RIC: TEML.BO, BB: TECHM IN) (Rs) 600 500 400 300 200 100 0 Oct 16 Dec 16 Source: Bloomberg Feb 17 Apr 17 Jun 17 Aug 17 Oct 17 Tech M s 2QFY18 results were inline with our estimates on revenues but delivered a beat on EBIDTA margin and PAT. Revenues at USD1179.2mn were up 3.6% QoQ and marginally above our estimates (PLe: USD1177mn). Revenues grew by 2.5% QoQ organically in USD (1.2% Organic growth in Constant Currency). Telecom vertical revenues (~43.7% of total revenues) were flat QoQ while Enterprise vertical (~57% of total revenues) grew by 6.1% QoQ (4% Organically). EBIDTA margin for the quarter came 14.5% up 180bps QoQ and above our estimates (PLe: ~13.5%). PAT came Rs8362mn was 19% above our estimates aided by margin beat and higher other income. Company reported second sequential quarter of headcount reduction in IT service segment. This has been the key driver for margin improvement. IT services Headcount came at 75,587 employees which represent a net decline of 3,400 employees QoQ. Tech M indicated of continued focus on margin improvement over coming quarters. Tech M has entered into an IP deal for Cloud and Virtualization product and would pay USD140mn for the deal (USD35mn paid in 2QFY18 and remaining to be paid in equal installments over a 12 quarter period). However, company indicated that it would give more details on this deal in 3QFY18. Aided by cross currency tailwind, we upgrade Tech M USD revenue growth assumptions to 9.5% for FY18 (vs 7.8% modeled earlier). This would imply an organic revenue growth of 6% in USD (4.2% constant currency YoY growth for FY18). Weakness in Telecom vertical owing to drag in LCC portfolio is leading to overall soft revenue growth for the company. We upgrade our EBIDTA margin assumptions to 14.2/14.8% for FY18/FY19E (vs 13.8/14.8% modeled earlier). Tech M already appears to have used headcount reduction as a margin lever over the past two quarters (IT services headcount down by 8% in 2QFY18 vs 4QFY17). We upgrade FY18 EPS estimates by 4.3% but we retain our FY19 EPS assumptions. Despite 18% rally over past three months, stock trades at 12.3x FY19E EPS and remains cheap. Infosys/ HCL Tech trading at 13/12.5x FY19E EPS. TP raised by 7% to Rs535/sh (13x Sep19E EPS vs 13x FY19E EPS earlier). Retain BUY Key financials (Y/e March) 2016 2017 2018E 2019E Revenues (Rs m) 264,942 291,408 308,402 340,053 Growth (%) 17.1 10.0 5.8 10.3 EBITDA (Rs m) 43,184 41,844 43,857 50,164 PAT (Rs m) 31,154 28,152 33,396 34,491 EPS (Rs) 35.1 32.1 37.5 38.7 Growth (%) 13.3 (8.5) 18.6 3.3 Net DPS (Rs) 13.1 9.0 11.4 11.8 Profitability & Valuation 2016 2017 2018E 2019E EBITDA margin (%) 16.3 14.4 14.2 14.8 RoE (%) 21.4 16.9 17.8 16.4 RoCE (%) 21.0 16.2 16.6 15.5 EV / sales (x) 1.5 1.3 1.2 1.0 EV / EBITDA (x) 8.9 9.1 8.3 6.9 PE (x) 13.9 15.2 12.7 12.2 P / BV (x) 2.8 2.4 2.2 1.9 Net dividend yield (%) 2.7 1.8 2.3 2.4 Source: Company Data; PL Research Q2FY18 Result Update Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision. Please refer to important disclosures and disclaimers at the end of the report
Exhibit 1: Q2FY18 Result Table (Rs mn) Q2FY18 Q1FY18 QoQ Q2FY17 YoY Ple Variance (Actual vs PLe) Sales (US $ mn) 1,179 1,138 3.6% 1,072 10.0% 1,177 0.2% Sales 76,064 73,361 3.7% 71,674 6.1% 75,925 0.2% EBITDA 11,057 9,347 18.3% 10,701 3.3% 10,250 7.9% EBITDA Margins 14.5% 12.7% 180 bps 14.9% 39 bps 13.5% 104 bps Net Income 8,362 7,987 4.7% 6,447 29.7% 7,060 18.4% EPS (Rs) 9.4 9.0 4.7% 7.3 29.7% 7.9 19.0% Revenues beat estimates: Revenues at USD1,179mn were up 3.6% QoQ and above our estimates (USD1,177mn). HCI acquisition consolidation contributed to incremental USD13mn for the quarter. Cross currency movement was a tailwind of 130bps QoQ. Hence, organic constant currency revenue growth for the quarter stood at 1.2% QoQ Exhibit 2: USD Revenue growth (QoQ) 7.0% 6.5% 6.0% 5.3% 5.0% 4.0% 3.0% 2.0% 1.0% 3.7% 2.6% 4.0% 4.1% 2.2% 1.4% 0.5% 0.4% 0.7% 0.9% 3.6% 0.6% 0.0% Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 * Growth includes acquisitions Exhibit 3: US$ Revenues and growth YoY in (%) USD revenues Growth (YoY) 1,300 1,200 1,100 1,000 900 800 855 901 924 984 989 1,011 1,015 1,023 1,032 1,072 1,116 1,131 1,138 1,179 22.0% 17.0% 12.0% 7.0% 700 2.0% Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18, acquisition have also aided in higher YoY USD revenue growth over FY15/FY16. November 01, 2017 2
Steep margin erosion: EBIDTA margin came in at 14.5% up 180bps QoQ and above our estimates (PLe: 13.5%). Headcount reduction in IT services business has been the key driver for margins in our view. Company would have to scout for new levers to drive further margin expansion over 3Q and 4Q. Exhibit 4: EBIDTA Margins vs. Average rate (USD vs. INR) EBITDA Margins Average rate 22.0% 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 18.1% 20.0% 20.2% 15.2% 14.9% 16.6% 16.9% 16.9% 14.9% 14.9% 15.7% 12.0% 12.7% 14.5% 70 68 66 64 62 60 58 56 Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Key Metrics Exhibit 5: Revenue mix by geography (%) Revenues by Geography Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Americas 45.4 47.7 48.9 47.8 46.8 49.0 48.3 46.7 45.1 46.8 45.3 Europe 29.8 29.4 29.3 28.9 28.5 28.3 29.7 29.4 29.6 29.8 30.0 ROW 24.8 22.9 21.9 23.2 24.7 22.8 22.0 23.9 25.3 23.4 24.7 ROW drove most of the revenue growth for the quarter Exhibit 6: Geography wise revenues (USD mn) and growth in revenues (%) Revenues and growth by geography Q2FY18 Q1FY18 QoQ Q2FY17 YoY Americas 534.2 532.6 0.3% 518.0 3.1% Europe 353.8 339.1 4.3% 318.5 11.1% ROW 291.3 266.3 9.4% 235.9 23.5% November 01, 2017 3
Exhibit 7: Revenue mix by verticals (%) Revenues by verticals Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Telecom 55.3 52.7 52.9 51.3 50.9 49.2 48.4 47.3 46.3 45.2 43.7 Manufacturing 16.5 17.1 16.7 17.1 17.1 18.1 19.2 18.4 19.2 19.3 19.0 Technology,media and Entertainment 7.0 7.3 8.2 7.4 7.5 7.5 7.2 6.4 6.2 6.0 5.9 BFSI 9.1 10 9.6 9.8 10.6 11.3 11.5 13.1 14.1 14.4 14.1 Retail, Transport and logistics 6.2 6.5 6 6.8 6.2 6.5 6.8 7.6 6.5 6.8 7.2 Others 6.0 6.5 6.6 7.6 7.7 7.3 6.8 7.1 7.7 8.3 9.9 Telecom vertical continued to remain weak on a directional basis with leakage in LCC remaining the key drag Exhibit 8: Vertical wise revenues (USD mn) and growth in revenues Revenues and growth by verticals Q2FY18 Q1FY18 QoQ Q2FY17 YoY Telecom 515.3 514.4 0.2% 519.0 0.7% Manufacturing 224.0 219.6 2.0% 205.9 8.8% Technology,media and Entertainment 69.6 68.3 1.9% 77.2 9.9% BFSI 166.3 163.9 1.5% 123.3 34.8% Retail, Transport and logistics 84.9 77.4 9.7% 72.9 16.4% Others 116.7 94.5 23.6% 72.9 60.1% Exhibit 9: Revenues by delivery (%) Revenues by delivery Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Onsite 61.1 61.0 61.7 62.7 63.2 63.4 63.5 63.9 64.3 63.7 64.1 Offshore 38.9 39.0 38.3 37.3 36.8 36.6 36.5 36.1 35.7 36.3 35.9 Exhibit 10: Client Metrics Revenues by client Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Top 5 client 33.0 33.0 32.0 28.0 27.9 28.8 28.5 27.8 26.6 25.9 24.8 Top 10 clients 45.0 44.0 43.0 40.0 39.0 40.0 39.9 38.4 37.6 36.3 35.1 Top 20 57.0 57.0 56.0 52.0 51.9 52.6 51.7 50.5 49.0 48.5 46.2 Client Bucket >1 m 291 296 298 326 319 317 341 356 354 377 390 > 5 m 96 101 102 105 112 120 120 128 134 139 147 > 10 m 56 60 62 63 63 64 66 65 71 74 81 >20 m 35 36 36 37 40 42 40 38 36 41 40 > 50 m 13 13 14 14 14 14 14 14 14 14 14 November 01, 2017 4
Exhibit 11: Headcount Details 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 2QFY18 Software Professionals (IT services) 71657 71892 72,125 73590 78,404 80,858 82,403 78,996 75,587 BPO 26,513 28279 27,254 27,326 27,669 29,372 28,414 30,322 35,287 Sales and Support 7,065 6966 6,053 6,300 6,813 6,865 6,876 6,662 6351 Total Employees 105,235 107,137 105,432 107,216 112,886 117,095 117,693 115,980 117,225 Net addition 1,562 1,902 (1,705) 1,784 5,670 4,209 598 (1,713) 1245 IT Attrition 20% 20% 21% 21% 19% 18% 17% 17% 16% IT Utilization 77% 77% 77% 78% 78% 77% 77% 77% 81% IT utilization (Excluding trainees) 79% 80% 80% 80% 82% 83% 81% 81% 81% Company has shown steep reduction in IT services headcount over the past two quarters. IT Services headcount came at 75,587 employees down 8% over 4QFY17. November 01, 2017 5
Exhibit 12: Financial summary of Tech M FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E USD Revenues (USD mn) 2632 3098 3664 4038 4351 4763 5232 5714 Growth (%) 6.8% 17.7% 18.3% 10.2% 7.8% 9.5% 9.8% 9.2% Organic Growth (%) 6.8% 12.7% 14.4% 1.0% 3.9% 6.0% 9.8% 9.2% Average Rate ( USD vs. INR) 54.46 60.72 61.20 65.60 66.97 64.50 65.00 65.00 Revenues (Rs mn) 143,320 188,313 226,213 264,942 291,408 308,402 340,053 371,441 Growth (%) 22.5% 31.4% 20.1% 17.1% 10.0% 5.8% 10.3% 9.2% EBIDTA 30,632 41,837 41,529 43,184 41,843 43,857 50,164 55,716 EBIT 26,736 36,615 35,415 35,564 32,062 33,412 39,713 44,573 APAT 21,157 26,821 26,277 31,180 28,409 33,396 34,491 38,397 EBIDTA Margin (%) 21.4% 22.2% 18.4% 16.3% 14.4% 14.2% 14.8% 15.0% EBIT Margin (%) 18.7% 19.4% 15.7% 13.4% 11.0% 10.8% 11.7% 12.0% NPM (%) 14.8% 14.2% 11.6% 11.8% 9.7% 10.8% 10.1% 10.3% Adjusted Diluted EPS (ex Treasury) 24.62 31.21 30.58 35.12 31.94 37.55 38.78 43.17 Growth (%) 17.1% 26.8% 2.0% 14.9% 9.1% 18.7% 3.3% 11.3% P/E(Ex Treasury Share EPS) 16.2 12.8 13.1 11.4 12.1 12.7 12.2 11.0 EV/EBIDTA 11 8 9 8 8 9 8 7 ROE (%) 36.3% 33.5% 24.5% 23.4% 18.4% 19.1% 17.5% 17.4% Consolidated Balance sheet ( Rs mn) Net Cash on Balance Sheet 25606 31444 24904 41575 36273 51,172 69,763 104,740 Net Cash per Share on balance sheet 27.6 33.8 26.0 42.3 40.8 57.5 78.4 117.8 Net cash per share as a % of stock price 6.9% 8.5% 6.5% 10.6% 10.6% 12.1% 16.5% 24.8% Consolidated Cash Flows ( Rs mn) Cash flow from Operating Activities 18994 15928 23974 32132 40714 28,848 37,508 38,740 Capex+ Acquisitions (10,250) (10,508) (24,873) (9,046) (21,272) (9,000) (9,000) (9,000) Free Cash Flow 8,744 5,420 (899) 23,086 19,442 19,848 28,508 29,740 FCF/EBIDTA 28.5% 13.0% 2.2% 53.5% 46.5% 45.3% 56.8% 53.4% November 01, 2017 6
Income Statement (Rs m) Y/e March 2016 2017 2018E 2019E Net Revenue 264,942 291,408 308,402 340,053 Software Expenses 174,810 154,539 219,079 240,615 Gross Profit 90,132 136,869 89,323 99,438 Other Expenses 46,948 95,025 45,466 49,274 EBITDA 43,184 41,844 43,857 50,164 Depr. & Amortization 7,620 9,781 10,446 10,450 Net Interest 961 1,286 1,156 800 Other Income 5,566 7,776 12,129 6,400 Profit before Tax 40,169 38,553 44,385 45,313 Total Tax 8,602 10,021 10,727 10,422 Profit after Tax 31,567 28,532 33,658 34,891 Ex Od items / Min. Int. 413 380 262 400 Adj. PAT 31,154 28,152 33,396 34,491 Avg. Shares O/S (m) 888.7 877.6 877.6 877.6 EPS (Rs.) 35.1 32.1 38.1 39.3 Balance Sheet Abstract (Rs m) Y/e March 2016 2017 2018E 2019E Shareholder's Funds 155,981 176,685 198,453 220,928 Total Debt 1,967 3,853 3,153 2,453 Other Liabilities 7,562 16,207 16,469 16,869 Total Liabilities 165,510 196,745 218,075 240,250 Net Fixed Assets 32,383 41,040 39,594 38,144 Goodwill 17,357 26,279 26,279 26,279 Investments 13,244 3,319 3,319 3,319 Net Current Assets 96,657 99,345 122,127 145,752 Cash & Equivalents 51,828 53,833 66,332 83,723 Other Current Assets 114,389 109,441 119,910 127,459 Current Liabilities 69,560 63,929 64,115 65,430 Other Assets 5,869 26,753 26,753 26,753 Total Assets 165,510 196,745 218,075 240,250 Cash Flow Abstract (Rs m) Y/e March 2016 2017 2018E 2019E C/F from Operations 32,132 40,714 28,848 37,508 C/F from Investing (14,668) (30,489) (2,871) (6,600) C/F from Financing (5,653) (7,799) (13,879) (13,917) Inc. / Dec. in Cash 11,811 2,426 12,098 16,991 Quarterly Financials (Rs m) Y/e March Q3FY17 Q4FY17 Q1FY18 Q2FY18 Net Revenue 75,575 74,950 73,361 76,064 EBITDA 11,865 8,987 9,347 11,057 % of revenue 15.7 12.0 12.7 14.5 Depr. & Amortization 2,480 2,835 2,468 2,653 Net Interest (1,203) (2,060) (3,737) (2,836) Other Income 1,552 2,378 4,107 3,222 Profit before Tax 10,588 8,212 10,616 11,240 Total Tax 2,141 2,316 2,698 2,847 Profit after Tax 8,560 5,879 7,987 8,362 Adj. PAT 8,560 5,879 7,987 8,362. Key Financial Metrics Y/e March 2016 2017 2018E 2019E Growth Revenue (%) 17.1 10.0 5.8 10.3 EBITDA (%) 4.0 (3.1) 4.8 14.4 PAT (%) 17.2 (9.6) 18.6 3.3 EPS (%) 13.3 (8.5) 18.6 3.3 Profitability EBITDA Margin (%) 16.3 14.4 14.2 14.8 PAT Margin (%) 11.8 9.7 10.8 10.1 RoCE (%) 21.0 16.2 16.6 15.5 RoE (%) 21.4 16.9 17.8 16.4 Balance Sheet Net Debt : Equity (0.3) (0.3) (0.3) (0.4) Net Wrkng Cap. (days) 64 40 59 55 Valuation PER (x) 13.9 15.2 12.9 12.4 P / B (x) 2.8 2.4 2.2 1.9 EV / EBITDA (x) 8.9 9.1 8.3 6.9 EV / Sales (x) 1.5 1.3 1.2 1.0 Earnings Quality Eff. Tax Rate 21.4 26.0 24.2 23.0. November 01, 2017 7
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