We downgrade Cyient to REDUCE from ADD post a weak performance and bleak growth outlook. Services growth and margin performance in 4Q was disappointing. Growth in 1HFY21 will be severely impacted due to structural problem in A&D and supply side (Covid related) issues in Communication and Transportation verticals. Cyient’s higher mix of mechanical services and elevated exposure to stressed verticals has magnified the Covid-19 impact vs. its peers. We have reduced EPS est. by 16.4/13.8% for FY21/22E. Our TP stands Rs 240, based on 9x FY22E EPS, which is at ~30% discount to 5Y avg. 1Y-fwd P/E multiple.
* Revenue stood at USD 149.2mn, down 3.9/9.7% QoQ/YoY (-3.7% QoQ CC) vs. est. of USD 153mn. Services (89% of rev) posted fourth consecutive quarter of YoY decline (-8.8% YoY CC) vs. est. of -5.2% YoY. Covid impact was ~USD 9.7mn (~6% of rev). Cyient’s revenue was down 4.0% YoY in CC terms vs. +12.8/+1.8% YoY CC growth for HCLT/Wipro ER&D division. DLM (11 % of rev) was up 11.9% QoQ but 1H will be challenging. Management has indicated of a steep fall of ~15-20% QoQ in 1QFY21E (our est. -16.4%).
* Aerospace & Defence (34% of rev, -4.8% YoY CC) has been struggling to grow due to structural issues in Top accounts. The sharp drop in commercial aircraft activity due to Covid-19, will impact the MRO revenue and recovery will be elongated. Communication/Transportation verticals (25/11.4% of rev) are impacted due to supply side constraints (lock down), 1H will have significant volume impact, but recovery will be visible in 2HFY21E.
* EBIT Margin contracted 118 bps QoQ to 8.4% (lowest ever) vs. est. 9.6%. Services margin stood at 9.6% down 100bps QoQ. The margin recovery will be linked to growth and 4QFY21 exit will be similar to 4QFY20. Cyient’s higher mix of mechanical engineering (legacy) services explains the poor growth metrics and the lower margin structure compared to ER&D peers.
* The cash conversion (FCF/EBITDA) improved to 56.9% in FY20 from 48.4% in FY19 due to drop in DSO days. Net cash stands at Rs 6.19bn (~24% of Mcap). RoE dropped to 14.5% in FY20 from 20% in FY19.
* Cyient is struggling with issues such as
(1) Stress in services portfolio,
(2) Stress in top accounts
(3) Issues in core vertical (A&D),
(4) Focus on lower margin DLM business and
(5) Lower margins structure due to investments and muted growth.
Concerns related to slowdown in decision making, Covid-19 related uncertainty and higher mix of legacy services remain. We expect USD revenue growth of -20.0/+7.8% and EBIT% of 7.8/8.8% for FY21/22E. The stock is down ~50% in 3M and trades at P/E valuation of 10.0/8.7x FY21/22E (vs. 5Y avg. of 13.5x)
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