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Strong demand and improving deal flow to drive growth in FY23

Supply pressures to keep margin stable

LTTS reported a 3.6% QoQ CC growth in 4QFY22, 90bp below our estimate due to softer growth in Industrial Products (-0.5% QoQ), Medical Devices (flat QoQ), and Telecom and Hi-Tech (+1.1% QoQ), while Transportation grew a robust 7.8% QoQ. Despite the large 400bp shift in its on-site revenue mix and lower utilization (-80bp QoQ), operating margin was flat QoQ. Attrition spiked to 20.4% (+290bp QoQ) in 4QFY22, indicating continued supply pressures. The company bagged its second over USD100m deal (after winning a historical first in Dec’21) from Jaunt Air Mobility in the Aerospace vertical. USD CC revenue/INR EBIT/INR PAT grew 20%/52%/44% YoY in FY22.

While the management’s initial FY23 revenue growth guidance of 13.5- 15.5% was disappointing, their vertical commentary and deal momentum (six deals of over USD10m in 4QFY22) suggest that its guidance trajectory should mirror that of FY22 where there was a gap of almost 500bp between its initial guidance and final growth. With the scaling up of new deal wins from 2QFY22 onwards, we remain confident of LTTS delivering a revenue growth of 17.5% in FY23. With continued additions to its workforce (LTTS grew its staff count by 27% in FY22, despite elevated attrition) and an improving deal pipeline, we continue to view the company as a beneficiary of structural demand tailwinds.

LTTS should see a flattish margin performance in FY23, despite a strong revenue growth, due to continued supply-side pressures (attrition rose to 20.4%). We expect it to deliver an EBIT margin of 18.4% in FY23, in line with its over 18% guidance. We expect the favorable pyramid and trimming of low margin accounts in the Telecom vertical to more than offset the continued pressure on employee expenses and travel resumption.

We continue to view LTTS as a beneficiary of the growing penetration of ER&D Services and the best Tier II IT Services play within our coverage universe. We lower our FY23-24 growth estimate, but have factored in an 18%/21% USD revenue/INR EPS CAGR over FY22-24.

We lower our FY23-24 EPS estimate by 4-5% due to the 4QFY22 miss and weaker guidance. We maintain our Buy rating and marginally tweak our TP to INR5,280 per share (40x FY24E EPS).

Modest revenue growth in 4QFY22, FY23 guidance below our expectation

In CC terms, revenue grew 3.6% QoQ, INR EBIT rose 37% YoY, and INR PAT increased by 35% YoY in 4QFY22.

USD revenue/INR EBIT/INR PAT grew by 19.5%/52.1%/44% in FY22.

Revenue rose 3.1% QoQ CC to USD232m in 4Q and by 3.6% in FY22.

LTTS bagged six deals, of which one was over USD100m, another was more than USD25m, and the rest were over USD10m.

Revenue from Digital and leading-edge technologies stood at 57% in 4Q v/s 56% in 3QFY22.

The top five/10 clients grew 2.5%/2.3% QoQ. The top 20 clients registered a softer growth of 2.4% QoQ.

Telecom and Hi-Tech/Transportation/Plant Engineering grew by 1.1%/7.9%/ 3.1% QoQ, while Medical Devices/Industrial products fell by 0.4%/0.6%.

The management guided at a FY23 USD revenue growth of 13.5-15.5%.

EBIT margin was flat QoQ at 18.6% (missed our estimate by 40bp) in 4QFY22.

The margin miss was due to a 400bp shift in on-site revenue mix, net employee addition of 743, and lower utilization (-80bp QoQ).

PAT rose 5% QoQ to INR2.6b, 5% below our estimate.

Total employee strength stood at 20,861 employees. Attrition rose 290bp sequentially to 20.4%.

Key highlights from the management commentary

Within Transportation, demand remains strong in Auto, Trucks, Aerospace, and Off-Highway Equipment. ESEV is a huge tailwind for the segment, with a visibility of three-to-five years. The management continues to remain bullish on this segment. It won one USD100m multi-year deal in the Aerospace segment.

Within Plant Engineering, it sees good demand for EPCM and Automation. The management said that clients are increasingly looking at smaller local plants. It sees good traction in sustainability, carbon capture, water waste management, etc.

For Industrial Products, demand is intact and the deal pipeline continues to remain strong.

In Telecom and Hi-Tech segment, the management said that semiconductors will propel growth and the outlook remains strong. It shared its plans to open 5G laboratory to tap this opportunity.

LTTS has established a new Metaverse unit to tap the huge opportunity that lies ahead in this space.

Within Medical Devices, it bagged a few projects in component engineering and medical devices. It continues to remain bullish on this business.

The management guided at 13.5-15.5% revenue growth for FY23 and said it remains conservative like last year. However, it is confident of an USD1b runrate in 2Q/3QFY23.

The management continued with its sustainable long-term margin guidance of over 18%. While its current margin performance trends over 18%, it sees a few headwinds from: 1) a gradual increase in travel cost, 2) supply-side challenges and a wage hike, and 3) inorganic investments. Tailwinds to margin include: a) growth and the quality of revenue, b) economies of scale, and c) productivity improvements.

Valuation and view

Digitization is driving the accelerated spends in ER&D and LTTS should benefit due to: 1) its strong capabilities, 2) multi-vertical presence, and 3) solid wallet share. We expect the company to deliver strong revenue growth over the coming years and retain it as our top pick in the Tier II IT Services space.

The management expects strong growth in the medium term, which implies a growth momentum of ~20% over FY21-25E. We view this as an indication that there can be potential upside risk to its USD1.5b revenue aspiration by FY25.

After a sharp dip in margin in FY21, LTTS has managed to clock a record high margin. We expect it to sustain in a narrow band.

Our TP of INR5,280/share implies 40x FY24E EPS. We expect improved industry spends v/s the preceding five years. We maintain our Buy rating.

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