Summary of Contents
STOCK UPDATE CMC
Recommendation: Buy
Price target: Rs1,500
Current market price: Rs1,302 Price target revised to Rs1,500 Result highlights Performance below expectations: For Q1FY2014, CMC has reported a 7.1% drop in its revenues to Rs486.6 crore, which is lower than our expectation of Rs513.4 crore. The decline in the top line was higher than expected because of a slower than expected growth in the system integration (SI) segment during the quarter. Despite the rupee's tail wind, the SI business grew by only 7.8% quarter on quarter (QoQ) in Q1FY2014 after a 13.9% sequential decline in Q4FY2014. On the other hand, the performance of the customer service (CS) business (whose revenues fell by 38% QoQ) and the information technology enabled services (ITES) business (whose revenues grew by 4.3% QoQ) was broadly in line with our expectations. The revenues of the services business grew by 5.3% QoQ (90% of the total revenues as against 79.4% in Q4FY13) whereas the revenues of the equipment business plunged by 55% QoQ (after a strong growth of 283% QoQ in Q4FY2013; 10% of the total revenues). The revenues from the international business rose by 8.7% QoQ to Rs314.1 crore driven by currency tail winds whereas the domestic revenues dropped by 26.5% to Rs172.5 crore on account of a fall in the revenues of the hardware business.
Margins remain stable; management expects improvement in coming quarters: The operating profit margin (OPM) remained broadly stable at 15.8% against 15.6% in Q4FY2013. The quarter's margin performance was below our expectations (we had expected an OPM of 16.8%). The underperformance can be attributed to a higher than expected increase in the sub-contracting cost (which rose by 18.8% QoQ driven by the execution of a higher number of onsite projects) and a lower than expected contribution from the high-margin lease rental segment. Despite improvement in the currency tail wind, the management has maintained its margin corridor of 16-17% for FY2014. Net income declined by 13% QoQ: The quarter's other income was significantly higher (up 148% QoQ) at Rs10.1 crore on account of a sale of property that generated Rs4.2 crore during the quarter. Further, the effective tax rate rose by 1,200 basis points QoQ to 34.4% on account of Rs9.6 crore dividend distribution tax on the dividend received from CMC Americas. The net income for the quarter fell by 13% QoQ to Rs53.1 crore, which is lower than our expectation of Rs64 crore.
Valuation: A slower than expected ramp-up in the performance of the key revenue-earning segments (SI and ITES) has upset CMC's growth trajectory tapering off its year-on-year (Y-o-Y) revenue growth rate to single digits in Q1FY2014 (the lowest in 12 quarters). The delay in improving in the revenue mix (onsite revenues still contribute over 75% of total revenues) has led to cost pressure and restricted any meaningful improvement in the margin. Nevertheless, the company's management indicated this quarter's performance was a quarterly aberration. It expects the growth momentum to improve in the quarters ahead and the revenue growth to be higher than the industry average in FY2014. In view of the lower than expected performance and increased tax rate assumptions, we have reduced our earnings estimates for FY2014 and FY2015 by 9.6% and 9.2% respectively. Consequently, we have reduced our price target to Rs1,500. From a longer-term perspective, we remain positive on CMC, given its strong earnings visibility led by its "joint go to" market strategy with Tata Consultancy Services, the successful traction in its products and solutions, and its proven expertise in the projects of the domestic government. We maintain our Buy rating on the stock with a revised price target of Rs1,500. NIIT Technologies
Recommendation: Hold
Price target: Rs305
Current market price: Rs261 Soft quarter Result highlights Soft quarter: For Q1FY2014, the numbers of NIIT Technologies Ltd (NTL) were below our expectation on both the top line and bottom line front. Though seasonally Q1 has always been a soft quarter for NTL, but overall the headline numbers coupled with an increase in the DSO days do not augur well for re-rating the company's stock, at least in the near term. The revenues were up by 0.9% quarter on quarter (QoQ) to Rs541.9 crore, which is lower than our expectation of Rs549.9 crore. Excluding hardware revenues of Rs59 crore, the revenues were down by 5.3% QoQ to Rs482.9 crore. The operating profit margin (OPM) for the quarter declined by 200 basis points to 14.4% (which is tad lower than our estimate of 14.9%). The decline in the margin was largely attributed to the annual wage hikes effective during the quarter. The management expects the margin to improve in the coming quarters. For the quarter, the other income stood at Rs20.6 crore as against a loss of Rs1.4 crore in Q4FY2013. The significant jump in the other income was on account of Rs17 crore foreign exchange (forex) translation gains against a loss of Rs5.9 crore in Q4FY2013. Further, the effective tax rate has gone up substantially to 35% attributed to the dividend distribution tax of Rs9.4 crore. The net income for the quarter was down by 6% QoQ to Rs53.2 crore (our estimate was Rs56.9 crore). Working capital intensifies, DSO days touched 98 days: NTL's focus on safeguarding the revenue predictability with increasing contribution from the government business (13% of the total revenues, up from 8% in Q1FY2013) has started taking toll on its cash flows. For the quarter, the DSO days went up by 16 days to reach 98 days at the end of the quarter (highest in the last 11 quarters). Thus, the cash and cash equivalents declined by Rs85 crore QoQ to Rs247.9 crore. The management acknowledged that the higher government contracts have impacted the DSO days. Further, with two government contracts on anvil (AP Finance, already started, and Airports Authority of India [AAI], to commence from Q2FY2014), the pressure on DSO days is unlikely to subside in the near term. Though the management expects that the newer management projects will have a better billing cycle but we remain sceptical on that. Valuation: Absence of any meaningful improvement in the earnings performance coupled with a changing mix of business is holding up the case for re-rating of NTL. Though we still see NTL among the few mid-cap information technology (IT) companies, which have rich potential for earnings improvement, the wait for improvement seems to be getting longer than anticipated earlier. We have revised our currency estimates and tweaked our earnings estimates for FY2014 and FY2015E. At the current market price (CMP) of Rs260, the stock is trading at 6.2x and 5.6x its FY2014 and FY2015 earnings estimates respectively. We maintain our Hold rating on the stock with a price target of Rs305.
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