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Strong print, favourable valuations

Cyient has reported group revenue of US$156.7mn in Q4FY22. Although revenue declined 0.8% QoQ US$ and 0.4% QoQ CC, it was slightly better than our estimate. Services revenue stood at US$130.6mn, up 1.1% QoQ (1.6% in CC), while DLM revenue declined 9.3% QoQ. C&U witnessed sequential growth of 3.8% and portfolio was relatively flat; marginal decline in transportation growth was due to rail transportation. Margin performance was strong at 14.5% (+60bps, +180bps YoY) vs our estimate of 12.8% and services margin was 15.4% (23bps QoQ, 179bps YoY). PAT stood at Rs1,542mn for the quarter with growth of 17.1% QoQ and 39.3% YoY, ~30% higher than our estimates, primarily led by higher other income. Offshore mix for Q4 at 51.6% is the highest ever.

Management guided for revenue growth in the range of 13–15% CC in FY23 for group and high single digit for DLM. We expect Cyient to deliver group growth of 14% YoY US$, 15% YoY in services business and 9% YoY US$ in DLM. EBIT margin guidance stands at 13-14% and we forecast it at 13.3% for FY23. Guidance for tax rate stands at 27% for FY23.

We believe the drag on the overall performance on account of semi-conductor issue in the DLM business should be offset by an outperformance in the services segment. Post management / strategy change, improved performance in the company is noteworthy and continued execution of the same should make Cyient a good turnaround story. Management’s confidence to sustain an elevated level of margin in services segment is a key positive given supply-side cost pressures. Services margin above 15% in FY23E should be aided by improved pricing, pyramid rationalisation and automation

We build in revenue/EPS CAGR of 13%/10% over FY22-FY24E. Cyient currently trades at 17/14x FY23/24E P/E, PEG of ~1x vs the ER&D sector trading at 40x FY24E for FY22-FY24E EPS CAGR of 20% and PEG ratio of 2x. We upgrade the stock to BUY from ADD as the stock has fallen 12% in the last one month and the risk-reward ratio looks very attractive to us at just 14x PE on FY24 EPS of Rs58. We value the stock at 18x target PE multiple (unchanged) to arrive at a revised TP of Rs1,037 (prior: Rs1,025). Cyient remains our only pick in the ER&D sector as valuations are highly reasonable.

Revenue above estimates: Cyient reported group revenue of US$156.7mn, down 0.8% QoQ US$ and 0.4% QoQ CC, although revenue was slightly above our estimate. Services revenue at US$130.6mn grew at 1.1% QoQ (1.6% in CC) and DLM revenue declined 9.3% QoQ. C&U witnessed sequential growth of 3.8% and portfolio was relatively flat with marginal decline in transportation growth due to rail transportation

In terms of geography, North America (+7.9% QoQ) led growth, while EMEA and APAC declined 2.9% and 15.2% QoQ, respectively. In services segment, communications led growth at 6.4% QoQ followed by portfolio (0.6% QoQ), while other verticals dragged growth.

Segmental colour and outlook: Aerospace (-0.5% QoQ) though sluggish has picked up momentum and management expects it to be at pre-covid levels by the end of FY23. Robust growth in communications should continue going into FY23 as well. In case of Rail transport, while H1FY23 is likely to be muted, H2FY23 should report robust traction. Within portfolio, growth is coming in from medical and semiconductor spaces

Management mentioned aerospace sector in general is showing good recovery, which is now more evenly distributed as against on selected accounts previously. The growth of this business is related to off-shore work as well as defence, requiring local execution and there is also strong interest in urban air mobility segment.

Rail continued to see muted growth on account of consolidation at some of the major accounts for Cyient. While all major customers of Cyient have a healthy orderbook, short-term pressures due to consolidation and insourcing will remain and can expect strong bounce back in next 2 quarters. DLM revenue witnessed decline in growth in Q4FY22 as raw material availability and longer lead-time continue to remain a challenge to execute order backlog. We believe it will persist in Q1FY23.

Communications unit witnessed strong sequential growth of 6.3% in Q4FY22, which was the best ever. It won three major deals in Q4, one from a key client in Canada to accelerate its broadband network rollout. This deal is the largest ever single project it won in this space. The outlook for this segment in FY23 remains positive supported by favourable industry trends and enabled by the company’s strategic transformation programme focusing on NextGeneration Networks.

Utilities unit witnessed decline in growth in Q4FY22 owing to cyclicality in major project execution; management expects strong rebound in this vertical in FY23.

Strong revenue guidance: Management guided for revenue growth of 13–15% in FY23 in CC for the group and high single digit in DLM. We expect Cyient to deliver group growth of 14% YoY US$, 15% YoY in services business and 9% YoY US$ in DLM. Margin guidance stands at 13-14% and we forecast it at 13.3% for FY23. Guidance for tax rate stands at 27% for FY23.

Strong operating print: Margins for the quarter stood at 14.5% (highest ever). Services margin was 15.4% while DLM was 9.8%. Increase in SG&A spend (- 200bps) was offset by change in revenue mix (+70bps), lower depreciation (+60bps) and improvement in operational metrics (+50bps)

Margin boost was due to management’s increased focus on operational efficiencies. Offshoring improved to 51.6%, +170bps QoQ. Utilisation was 86.1% (vs 86.2% QoQ). Contrary to industry trends, attrition dropped down ~240bps QoQ to 26.9%.

Management targets 20-25% attrition range for FY23 and is taking relevant measures to reduce the same.

FY22 saw 10-12% wage inflation in India and ~4% overseas. Management expects FY23 wage increase to be higher as supply crunch adds pressure to markets. The company is working on price increase with customers and management believes this to be a margin lever. However, in our understanding, such price increases will still take time to kick in

Other highlights. In-line with the industry, Cyient ramped up its hiring process with net addition of 583 employees in Q4FY22. FCF/EBITDA was 51% while FCF/PAT stood at 83%.

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