Wage Hike Drags Margin; Other Income Boosts PAT
Tata Elxsi (TEL) posted a 5.4% QoQ revenue growth in 2QFY19 with the key SDS segment leading the way with sharp 6% QoQ and 20.7% YoY growth. On the other hand, revenue from SIS segment declined by 11.6% QoQ and 36.4% YoY. TEL continues to focus on the higher-margin SDS business, with its revenue share at nearly an all-time high of 97.2%. EBITDA remained flattish (+0.2% QoQ) at Rs1.07bn owing to wage hike awarded to 90% of its employees. However, on YoY basis, TEL’s EBITDA surged by a robust 27%, aided by revenue growth (17.7% YoY) and operational efficiency, while its EBITDA margin grew by 194bps YoY to 26.5%. Higher other income (+197% QoQ, possibly owing to translation gains) boosted net profit (+16.6% QoQ). On the margin front, EBIT margin of SDS business rose by 186bps QoQ and by a substantial 412bps YoY backed by operating leverage and operational efficiency. EBIT in absolute terms rose by 12.3% QoQ and 37.9% YoY. On the other hand, SIS business’ EBIT margin rose 642bps QoQ and 174bps YoY to 17.4%.
Growth Outlook Remains Healthy; Stock Down on Macro Concerns
Going forward, given substantial growth being witnessed in digital portfolios of most IT firms, along with investments into avenues like connected cars, autonomous vehicles, AR/VR experience and automotive electronics, we believe TEL will be one of the key beneficiaries of the same, given its presence in these emerging businesses. We expect its diversified portfolio including automotive, broadcast, medical and design expertise to enable TEL to leverage these investments disproportionately. We would watch growth from IP-led engagements in future given scope for margin expansion, with the Autonomai platform a critical driver. Nonetheless, owing to macro concerns, global trade wars and issues with the British car industry - its largest client JLR has resorted to production freeze for 2 weeks owing to growth issues in China, and it reported 12.3% lower YoY retail sales in Sept’18 - the stock has corrected sharply over the past 2 days.
Outlook and Valuation
TEL achieved a healthy YoY growth in SDS business, while margin expansion is another positive. Looking ahead, we expect healthy growth, as the company focuses on niche verticals and services. We believe TEL is a good long-term investment bet, given its presence across fastgrowing solutions, niche area of operations, design expertise, marquee client base, pricing power, operating leverage, healthy cash flow, returns on capital and strong earnings growth. However, global macro concerns regarding trade wars and issues in the British car industry could keep the stock range-bound in the near-term. At the CMP, the stock trades at a PE of 19.5x/16.9x FY19E/FY20E EPS, respectively, which we believe to be reasonable in light of healthy growth and strong operating and financial metrics. Reducing our target multiple to 25x from 28x, we maintain our BUY recommendation on the stock with a revised Target Price of Rs1,440 (from Rs1,610 earlier).
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