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Cautious thesis manifesting; current weakness good time to accumulate. Maintain ADD
L&T Technology Services (LTTS) reported strong operating performance as US$ revenues adjusted for client ramp-down grew 5% qoq (reported grew a modest 1.4% qoq) while Ebitm (at 17.1% vs. 16.5%/14.8% qoq/yoy and 15.7% EE) were ahead too. Though 14.8%/15.2% yoy growth in US$/CC is respectable,
1) trimming of US$ revenue growth guidance (12-14% vs.14-16% earlier) led by momentum loss in telecom and hi-tech, and
2) aggressive consensus estimates could weigh in the near term.
We were cautious in the past, given demanding valuations in challenging demand environment, deteriorating macro and discretionary nature of ER&D spends but always liked the underlying business fundamentals and believe potential weakness in shares could be a good time to accumulate. Trim belowconsensus estimates and retain ADD with Sept’20 TP of Rs 1,671 (Jun’20/Rs 1,783 earlier) set at 22x (23x) Sept’20 TTM EPS of Rs 74.9.
Guidance encouraging in challenging macro environment:
FY20E growth guidance is driven by healthy bookings, large deal wins, and traction in large customers. LTTS continues to witness strength in Process, Transportation, Medical, and Industrial while telecom & hitech could be weak driven by loss of momentum and Semiconductor softness. Geographically, traction across US continues, while Europe could recover. We trim our below consensus FY20E estimates and model US$ revenues of $ 809mn (11.9% yoy growth) vs. $ 828mn/14.5% earlier.
Medical/Transportation/Plant Eng./US lead quarterly growth:
Growth was led by Medical (8.0% of 1q revenues/15.6% qoq-CC); helped by Transportation (34.9%/7.6%), Plant Engg (15.3%/5.9%), and Industrial (19.6%/2.9%) while Telecom (22.3%/-13.8%) was weak. Geographically, growth was led by North America (60.9% of rev/4.8% qoq); while India (12.8%/-6.3%), RoW (10.7%/-3.6%) and Europe (15.6%/-1.1%) were weak.
Margin beat led by operational efficiency and SG&A leverage:
Ebitm increased 55/230bps qoq/yoy to 17.1% (15.7% EE) led by tailwinds from operating efficiency, SG&A leverage and revenue mix while visa cost (70bps) and rupee appreciation (30bps) were key headwinds. 2q key margin headwinds include wage hike impact (~160bps) while FY20E tailwinds could be
(1) offshoring of engagements,
(2) increasing contribution of managed services contracts,
(3) cost of delivery optimization through pyramid rationalization, and
(4) bill rate improvements. We maintain our ~16% FY20E EBITM assumption.
Potential weakness could be good time to accumulate:
Lowering of guidance could
1) weigh in the near term given demanding valuations, and
2) drive potential weakness in shares which could be a good time to accumulate given differentiation in 35% of business, large market opportunity, healthy bookings, B/S metrics and return ratios.
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