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Upbeat FY25 aspiration led by strong demand outlook

Growing tech adoption expanding its addressable market We attended LTTS’ Analyst Day, where the management spelt out its aspiration of achieving FY25 revenue of USD1.5b, along with 18% EBIT margin. The management indicated that digitization is driving accelerated spends in ER&D and should benefit it due to: 1) strong capabilities, 2) multi-vertical presence, and 3) solid wallet share. We expect LTTS to deliver strong revenue growth over the coming years and retain it as our top pick in the midcap IT Services space.

Strong growth in ER&D spending, coupled with higher outsourcing

* There is an acceleration of digitization within ER&D. Overall ER&D spending is expected to touch USD1.7-1.9t by CY23E from USD1.4t in CY20 (~11% CAGR over CY20-23E). Additional leavers of growth for ER&D players like LTTS include: 1) higher outsourcing, and 2) market share gains by Indian and European ER&D players.

* ER&D spending has witnessed lower levels of outsourcing earlier as it is a strategic investment for enterprises. However, LTTS is witnessing increased traction for outsourcing from its enterprise clients as: 1) clients have revisited core and non-core spending and are more open to outsource entire non-core areas of ER&D spending, leading to expanding deal sizes, and 2) clients’ priorities for ER&D services has been changed to quality, speed, and scale (v/s a cost focus earlier).

* Outsourced ER&D penetration in most of LTTS’ verticals is still in the low to mid-teens, implying significant scope for an increase in outsourcing.

LTTS well placed to capture the demand momentum

* LTTS is well placed to capture the overall demand momentum as it is one of the top pure play ER&D services companies globally. It works with 57 of top 100 global ER&D spenders.

* It also enjoys solid wallet share as it is among the top two vendors with most of its top 30 accounts, including being the top vendor for four out of the top five clients.

* LTTS’ multi-vertical presence (v/s a single or few verticals presence for its peers) allows it to leverage its cross vertical capabilities to build its solutions offerings.

* Given the strong demand and improved visibility, the management has guided at an USD1b/USD1.5b revenue run-rate by 2Q-3QFY23/FY25, with ~18% EBIT margin

* Its FY25 guidance implies a FY21-25 USD revenue CAGR of ~20%, and indicates high management confidence in both the demand environment as well as its ability to gain share in all key verticals.

* The management has increased its focus on scaling up large accounts along with large deals, which will drive growth. It sees scope for margin improvement, led by a further offshore shift.

Growth vision driven by six big bets and six dimensional glide path

* LTTS highlighted the six large areas of corporate investment, where it sees significant opportunities, terming them big bets. These include EACV (electric, autonomous, and connected vehicles), medtech, 5G, AI and Digital products, Digital manufacturing, and sustainability.

* It also shared the six dimensions of its business focus (glide path), which include achieving industry-leading growth, customer centricity, people engagement, technology quotient, sustainable operating model, and ESG.

Valuation and view – industry-leading growth to defend rich multiples

* The management has provided a strong outlook, which implies a growth momentum of ~20% over FY21-25E. Moreover, it reiterated its focus of keeping its guidance achievable, despite client and attrition related risks. We see this as an indication that there can also be potential upside risk to its aspiration of USD1.5b revenue by FY25.

* The management is confident of maintaining segmental margin, despite the near-term headwind from a tight supply environment. Moreover, its medium term margin outlook of ~18% EBIT implies a margin expansion.

* Our TP of INR4,530 per share implies 39x FY23E EPS (v/s 31x earlier), given its strong medium term guidance and increased earnings visibility. We maintain our BUY rating.

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