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Slower growth in Services, but margins holding up well; Buy

At $151m (flattish q/q, ~8% y/y organic), Cyient’s Services grew slower in Q2 than its 8-11% y/y range for the last four quarters (LTTS, 13-18% y/y range, ARe). Order intake was $129m, up 5% y/y (LTM up 12% y/y). Cyient aims at 13-15% CC (incl. DLM) organic growth in FY23, unchanged, suggesting slightly higher for Services. The Services EBIT margin was 12.5%, flattish despite wage hikes; FY23 outlook was unchanged at 13.5- 14.5% (13-14% for the group). Cyient has decided to segregate DLM and is exploring various ownership structures. Hence, management focus on services is likely to be better ahead. There were one offs in Q2, adjusting for which, there is no major change to estimates. TP is Rs1,030, 15x FY25e EPS

Services growth driven by New Growth, Aerospace, MEU. Within Services, New Growth (up 9% q/q CC), Aerospace (up 3%) and MEU (up 3.9%) did well while Rail (down 8%) dragged. The company is seeing steady demand revival in Aerospace and expects Defence (15-20% of Aerospace) to do well in the present environment. Rail is expected to stabilise only toward the year end. Order intake was weak due to seasonality (per management) and is likely to recover ahead. Cyient closed five large deals in Q2 (four from Services), amounting to $105.2m. Citec and Celfinet were integrated for respectively one and three months.

Services EBIT margin at 12.5%, down 30bps q/q. Cyient’s Q2 Services EBIT margin was flattish despite wage hikes (~150bp impact, completed 90% of wage hikes for the year). SG&A further inched up in Q2 (the highest in the last 11 quarters) on M&A integration. Operationally, offshoring at 48% offers headroom for margins in the medium term. The Services headcount was up 25% in Q2, reflecting growth optimism. The Q2 consolidated PAT margin was 5.7% (down 362bps q/q, 524bps y/y), hit by an exceptional item (180bps, legal expenses on defending a class action lawsuit in the US related to employment of individuals, expenses to persist in H2) and a M&A-related one-off (170bps).

Buy, with slightly lower target of Rs.1,030 (from Rs.1,160 earlier). The stock quotes at 11x FY25e EPS of Rs.68, attractive given expectation of rising growth and after factoring in risks due to the company’s acquisitive nature. We value Cyient at 15x FY25e EPS. Risk: M&A-integration-related.

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