BUY Steady momentum Sector: Information Technology Sensex: 15,883 CMP (Rs): 116 Target price (Rs): 155 Upside (%): 33.6 52 Week h/l (Rs): 176 / 1 Market cap (Rscr) : 1,297 6m Avg vol ( Nos): 54 No of o/s shares (mn): 111 FV (Rs): 5 Bloomberg code: INFTC IB Reuters code: INFE.BO BSE code: 532175 NSE code: INFOTECENT Closing price as on 4 Jan, 211. Shareholding pattern September '11 (%) Promoters 23. Institutions 29.7 Non promoter corp hold 8.6 Public & others 38.8 Performance rel. to sensex (%) 1m 3m 1yr Infotech Ent. (4.7) 4.9 (1.3) KPIT Cummins (.7) 2.1 23.2 Hexaware (.5) (4.4) 53. Mind Tree 3.2 18.3 (5.8) Share price trend 13 11 Infotech Ent. Sensex 9 7 5 Jan-11 May-11 Sep-11 Jan-12 Our discussions with Infotech Enterprises indicate steady business momentum, especially its engineering business which is experiencing continued demand traction. Its Network & Communications (N&CE) business too is on an improving trajectory with ramp downs in key client largely over and services mix improving favourably. Strong annuity-based revenues (~7% of total revenues) coming from long term service agreements lends decent visibility in times of uncertainty. OPM appears to have bottomed out in and its outlook remains sanguine with INR depreciation being a major lever followed by increased offshoring and improving employee pyramid. Valuations remain attractive. Maintain BUY. Engineering demand remains robust; Service mix improving Infotech s key business segments of Engineering and N&CE continue to perform well. Its key aerospace clients (55% of Engineering business) continue to involve the company in long term design/engineering programs. On the other hand, its N&CE business too has transformed incrementally moving away from its low-end services. Focused approach towards top clients, proven delivery (strong referrals) and high renewal rates adds to the comfort. Margins likely to have bottomed out Implementation of wage hikes, integration of low margin acquisitions and ramp down in key clients had led to strong margin erosion in FY11. Going forward, reduced exposure to low margin data conversion business, higher offshoring in key subsidiaries and improving employee mix along with a weak rupee are expected to expand margin. Valuations provide an attractive entry point Infotech s revenue traction has been consistent in past 6-8 quarters as it continued to benefit from its well entrenched position as an engineering services provider for its top clients. OPM which was a concern over FY11 has shown decent improvement in and should improve going forward. Sustained demand in Engineering segment (7% of total revenues), improving N&CE segment and protected margin makes us positive on the company. We incorporate weaker rupee assumptions in our estimates and maintain BUY Financial highlights Y/e 31 Mar Rs m FY1 FY11 FY12E FY13E Revenues 9,531 11,88 15,647 17,754 yoy growth (%) 7.1 24.6 31.7 13.5 Operating profit 2,83 1,87 2,625 3,49 OPM (%) 21.9 15.2 16.8 17.2 Reported PAT 1,78 1,398 1,468 1,937 yoy growth (%) 84.7 (18.2) 5. 32. EPS (Rs) 15.4 12.6 13.2 17.4 P/E (x) 7.6 9.2 8.8 6.7 P/BV (x) 1.4 1.3 1.1 1. EV/EBITDA (x) 5.1 5.2 3.7 2.9 ROE (%) 2.6 14.5 13.5 15.7 ROCE (%) 25.1 16.7 19.6 22.4 Research Analyst Aniruddha Mehta research@indiainfoline.com January 5, 212
Sustained demand in engineering SBU; Improving services mix in N&CE Sales team strengthening beginning to bear fruit Robust demand for engineering; Transformation of N&CE business Infotech s two SBUs of Engineering and N&CE provide decent comfort in terms of demand traction. On the engineering side, the company sees sustained demand especially on the aerospace (55% of Engineering revenues) and heavy equipment (16% of engineering revenues) clientele, which continue to spend on their core engineering programs/ platform. On the N&CE front, the services mix has improved materially with increase in proportion of higher priced services. The ramp downs from a key European telecom client too should bottom out in Q3 FY12. Large ticket sales personnel hiring done in Q4 FY1 also seem to be paying off as indicated by the decent deal wins, contract renewals and the order book size (highest in its history). Pricing too remains stable with no material pressure. Company has already got price increases in two of its top-5 accounts in H2FY11 and is in active discussions for pricing improvement with a couple of other clients. Revenues to grow at 17% CAGR over FY11-13E 4 (US$ mn) 32 24 16 8 FY1 FY11 FY12E FY13E Large engineering programs by key aerospace clients continue to benefit the company Deep relationships with top clients with an average of 6-7 years Robust demand in the engineering vertical Engineering business has been witnessing sustained traction in the past eight quarters posting at 7% dollar revenue Cqgr. Long term engineering programs of its key clients, especially in the aerospace domain, lend decent visibility. For instance, a group company of its top client UTC is in the midst of a large aircraft platform design program where Infotech is a key service provider. Long drawn Product/platform life cycles result in 4-5 year MSAs (master services agreement) is the chief reason for the comfort. Proven delivery coupled with competitive pricing bodes well to renew older deals which is evidenced in the average 6-7 year relationship with its top 5 clients (37% of revenues). Sustained traction in engineering SBU.. 6 Revenues qoq growth (US$ mn) (%) 5 4 3 2 1 Q2 FY1 Q3 FY1 Q4 FY1 15 12 9 6 3.. to post strong 18% CAGR over FY11-13E 3 (US$ mn) 24 18 12 6 FY1 FY11 FY12E FY13E Company Report 2
Strong employee addition in Engineering SBU 4 3 2 1 (1) (2) Q2 FY1 Q3 FY1 Q4 FY1 Ramp downs from important clients likely to bottom out Traditional mow margin services contribution reducing materially Transformation of the N&CE business N&CE business was traditionally involved in lower-end services (low priced) of map conversion, digitization and other GIS related services as a result leading to lower profitability. Ramp down of the Swiss com account and key European client too had a material impact on the business. Over the last two years, there has been appreciable improvement in the services mix especially post the acquisition of Wellsco (telecom engineering company acquired in ). The traditional services now only form 3% of the total mix (versus 5% in Q2 FY1) with the newer services like FTTx (optimized solutioning in fibre optics projects), FTTm, smart grid technologies etc growing at a faster clip. The important European telecom client may further ramp down in Q3 FY12 but it would most likely be bottomed out by then. On the bright side, the order book for the N&CE business has built up to become the highest ever. Client ramp-downs impacted revenues of N&CE SBU Expect 14% dollar revenue CAGR over FY11-13E 3 Revenues q-o-q grow th (US$mn) (%) 2 12 (US$ mn) 25 2 15 1 9 15 1 5 6 5 (5) (1) 3 Q2 FY1 Q3 FY1 Q4 FY1 FY1 FY11 FY12E FY13E Company Report 3
Wage differential reset, ramp down of key account and integration of low margin acquisitions had led to margin erosion in FY11 Large part of the margin correction a thing of the past Ramp downs in important accounts near completion Contribution of higher margin services in N&CE business increasing from 5% to 7% in last two years Margin to have likely bottomed out As the company was reeling under demand contraction in CY9-1, wage hikes were postponed and as a result, margins were maintained at materially higher levels leveraging on the lower cost base. Ramp downs from key client Swisscom (~3% of the revenues), integration of lower margin acquisitions of Daxcon and Wellsco and reset of wage differential had led to sharp deterioration in the operating margin. Additionally, pricing pressure and ramp downs from certain clients and skewed hiring (more of laterals) to service sharp up-tick in demand post the crisis had a resultant impact on the profitability A material portion of the margin correction is thing of the past A large part of the factors that impacted the margin performance are turning favourable. In the coming quarters, we believe that the operating margin should improve and expect margins to improve appreciably over FY11-13. A variety of factors are expected to protect and expand the margins going ahead as follows: Ending of ramp-downs in key accounts Bottoming out of ramp downs in key account of Daxcon (Caterpillar) should lead to better profitability in the same going ahead. This is evident in the results where company indicated that Daxcon has reached breakeven post 2-3 quarters of losses. Ramp down from the large European telecom client of N&CE business is also likely to halt post Q3 FY12. Margin should improve as these accounts ramp up/stabilize. Complexion of services in N&CE improving Earlier, the N&CE SBU was involved in low-end services like map conversion, digitization and other GIS related services. Post the acquisition of Wellsco, which is involved in higher-end services like FTTx (optimization of usage of high cost fiber cable) among others, the services mix of the N&CE business has improved materially. These services come at a better margin as compared to the traditional services. The change is evident in the reduced contribution of traditional lower end services of 3% of total N&CE which was 5% two years back. The improvement is more visible in the top 5 customers where the low-end services contribution has reduced from 4% to 2% over the same time frame. N&CE Services mix - Before N&CE Services mix - Current Traditional services New Services Traditional services New Services 5% 3% 5% 7% Note-Traditional services Map conversion, digitization, GIS related services. New Services-FTTx, FTTm, smart grid technologies etc Company Report 4
Increased offshoring from Wellsco clients and increased fresher hiring to be key operational levers going ahead Key operational levers to provide further support Company is targeting increased fresher hiring, higher offshoring from Wellsco clients to be key operational levers to support margin improvement. Company targets to increase the fresher contribution from current 35% to 4% in coming quarters. Improvement in utilization in Engineering business (currently 73%) also is an additional lever though could be offset to a certain extent by possible reduction in N&CE utilization, which is substantially high at 9%. SG&A leverage also is a credible lever going forward with SG&A costs (currently 28% of revenues) estimated to come down as a proportion of revenues. High onsite revenue contribution to come down 6 (%) 54 48 42 36 Utilization for N&CE and Engineering SBU N&CE Engg 1 (%) 9 8 7 6 3 5 Q2 FY1 Q3 FY1 Q4 FY1 Q2 FY1 Q3 FY1 Q4 FY1 Operating margin likely bottoming out 25 (%) 2 15 Margin performance to improve over FY11-13E 3 (%) 24 18 1 5 12 6 Q2 FY1 Q3 FY1 Q4 FY1 FY1 FY11 FY12E FY13E Company Report 5
Valuations provide an attractive entry point Infotech Enterprises has been registering decent revenue growth supported by sustained demand from its Engineering and N&CE clientele as well as inorganic traction (primarily Daxcon and Wellsco). We expect decent traction from the Engineering business largely due to continued spending by larger clients as well as long term nature of contracts signed by the company. Its N&CE business too is shaping up well both due bottoming out of key client (post ramp downs) as well as improving services mix. OPM too should improve as its key subsidiaries improve profitability through increased offshoring, stabilizing businesses as well as SG&A leverage. Rupee depreciation continues to be a strong lever for the industry and Infotech is no exception. Increased hedging (from ~US$85mn in to ~US$15mn currently) at higher rates to further benefit the company in FY13/14. We estimate the company to post 16% dollar revenue CAGR over FY11-13E with earnings growing faster at 18% CAGR. At 6.7x FY13E earnings we believe, valuations provide an attractive entry. Maintain BUY with a 9-month TP of Rs155. Company Report 6
Financials Income statement Y/e 31 Mar (Rs m) FY1 FY11 FY12E FY13E Revenue 9,531 11,88 15,647 17,754 Operating profit 2,83 1,87 2,625 3,49 Depreciation (436) (486) (51) (61) Interest expense (31) (16) (17) (2) Other income 464 293 14 39 Profit before tax 2,79 1,599 2,12 2,738 Taxes (55) (27) (78) (849) Share of IASI Profits 134 69 55 48 Net profit 1,78 1,398 1,468 1,937 Balance sheet Y/e 31 Mar (Rs m) FY1 FY11 FY12E FY13E Equity capital 277 556 557 557 Reserves 8,786 9,737 11,14 12,66 Net worth 9,63 1,293 11,571 13,217 Debt 44 5 - - Total liabilities 9,17 1,299 11,571 13,217 Fixed assets 2,692 2,99 3,38 3,67 Intangibles assets 463 471 471 471 Investments 2,23 913 98 98 Def. Tax Asset(net) 29 15 49 49 Net working cap 3,91 5,991 6,836 8,182 Sundry debtors 2,65 2,678 3,858 4,378 Cash 2,337 3,52 3,336 4,258 Other curr assets 1,661 2,193 2,779 3,17 Sundry creditors (1,157) (1,42) (1,372) (1,557) Other curr liab. (1,5) (1,34) (1,765) (2,3) Total assets 9,17 1,299 11,571 13,217 Cash flow statement Y/e 31 Mar (Rs m) FY1 FY11 FY12E FY13E Profit before tax 2,79 1,599 2,12 2,738 Depreciation 436 486 51 61 Tax paid (373) (255) (742) (849) Working capital (571) (925) (1,11) (425) Other oprt items 134 69 55 48 Operating CF 1,75 973 924 2,113 Capital exp. (391) (73) (9) (9) Free cash flow 1,314 27 24 1,213 Equity raised (218) (6) 1 - Goodwill (19) (8) - - Investments (1,62) 1,11 6 - Debt fin/disp (151) (38) (5) - Dividends paid (13) (162) (191) (291) Net in cash (996) 1,165 (166) 922 Key ratios Y/e 31 Mar FY1 FY11 FY12E FY13E Growth matrix (%) Revenue growth 7.1 24.6 31.7 13.5 Op profit growth 16.6 (13.2) 45.2 16.2 EBIT growth 15.7 (23.5) 32.4 29. Net profit growth 84.7 (18.2) 5. 32. Profitability ratios (%) OPM 21.9 15.2 16.8 17.2 EBIT margin 22.1 13.6 13.7 15.5 Net profit margin 17.9 11.8 9.4 1.9 RoCE 24.8 16.6 19.5 22.3 RoNW 2.4 14.4 13.4 15.6 RoA 15.8 11.7 1.7 12.3 Per share ratios EPS 15.4 12.6 13.2 17.4 Dividend per share 1.2 1.5 1.7 2.6 Cash EPS 19.3 16.9 17.7 22.8 Book value per share 81.5 92.5 14. 118.8 Valuation ratios P/E 7.6 9.2 8.8 6.7 P/B 1.4 1.3 1.1 1. EV/EBIDTA 5.1 5.2 3.7 2.9 Payout (%) Dividend payout 7.6 11.6 13. 15. Tax payout 24.3 16.9 33.4 31. Liquidity ratios Debtor days 79 82 9 9 Creditor days 44 32 32 32 Du-Pont Analysis Y/e 31 Mar FY1 FY11 FY12E FY13E Tax burden (x).82.87.69.71 Interest burden (x).99.99.99.99 EBIT margin (x).22.14.14.16 Asset turnover (x).88.99 1.15 1.13 Financial leverage (x) 1.29 1.24 1.25 1.27 RoE (%) 2.4 14.4 13.4 15.6 Company Report 7
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