IGI Logo

Sonata Software (Sonata) has reported IITS (international IT services) revenue at US$57.8mn (+4% QoQ CC, 1.8% QoQ US$, largely in line with our estimates) in Q2FY23. Its revenue still continues to be impacted by supply-side challenges and ~15-16% of revenue could not be fulfilled due to supply-related challenges. It expects supply-side challenges to ease over the next 1-2 quarters.

In IITS business, in terms of verticals, growth was led by ISV (4.6% QoQ US$) and healthcare (24.4% QoQ US$). Retail vertical business declined 3.2% QoQ US$ largely due to cross-currency headwinds as most clients are based out of Europe. Retail is likely to be impacted by macro concerns, but deal pipeline remains healthy in this vertical, as per the management. Travel vertical declined 11.4% QoQ US$ largely due to cross-currency headwinds, while volume growth in this vertical has been in line with company average, as per the management. Investments in sales engine are yielding results - Sonata signed two large deals in Q2FY23, including one from a Sweden based manufacturing company.

Segmental EBITDA margin in IITS business further dipped to 25.9% (-67bps QoQ / - 270bps YoY) due to supply-side challenges and investments in sales. Wage hikes for FY23 will be in Q4FY23 for majority of employees as per management. Sonata IT services’ headcount addition was strong at 8.1% QQ as company plans to tackle supplyrelated changes. It added 290 freshers in H1FY23. It will rollout wage hikes in Q4FY23. Due to continuous supply-side pressures, investment in sales and reversal of covidinduced cost savings, we expect margins to remain muted in IITS business in FY23

DPS (domestic products business) continued to sustain strong growth momentum, growing 21% YoY in Q2FY23. Cloud revenue share remained stable at 77% (vs 76% in Q1FY23). Annuity revenue share was also steady at 75% (vs 76% in Q1FY23). Improvement in DSO in domestic business done during covid has been largely retained with DSO at 37 days vs 32 days in Q2FY22

We increase EPS estimates by 3.4%/2.2% for FY23/24 led by beat in domestic business revenue in Q2FY23. We upgrade Sonata to ADD (prior: HOLD) led by 1) attractive valuations of 13x on FY24 EPS (close to 7-year average one-year forward P/E), 2) new leadership and investments in sales are expected to improve growth in international business and 3) sustained strong growth in domestic business. We continue to value the stock at 15x on FY24E EPS of Rs37 to arrive at a revised targ

Sonata won two large deals in Q2FY23. One with a Sweden-based manufacturing company which has Rs95bn+ revenue and the second with a SaaS-based talent management company. Management mentioned that large deals are 3 or 4-year contracts with margins higher than IT services’ margin

 In ISV segment, demand is led by product engineering with healthy deal pipeline.

 Deal pipeline is growing but management alluded to decision making delays.

Sonata added 290 freshers in H1FY23 (200 in Q2FY23 and 90 in Q2FY23). It intends to add 550 freshers in FY23. It has not slowed down campus hiring despite macro concerns since it is facing supply constraints and demand environment is strong.

Management aspires to double international business revenue in the next 4 years, implying ~19% CAGR over FY22-26.

In domestic business, demand is driven by cloud, and should continue to grow over the next couple of quarters at least as per the management. The company is witnessing good demand in Hi-Tech, BFSI and pharma in domestic business. Gross contribution stands at 5.3% vs 6.6% in Q2FY22 for this business

To Read Complete Report & Disclaimer Click Here

For More ICICI Securities Disclaimer https://www.icicisecurities.com/AboutUs.aspx?About=7

SEBI Registration Number INZ000183631

Above views are of the author and not of the website kindly read disclaime