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Recovery on the way

Attractive valuations; reiterate Buy

* SIS reported a lower than expected performance in 1QFY22, led by underperformance in the international business (-4.2% QoQ) on account of lower revenue from the ad hoc business (also high margin) and two months impact of the lockdown on the India Security business (-2.3% QoQ). This led to a sequential decline of 2.7%. Consequently, EBITDA margin was lower than our expectations (50bp) on weaker revenue performance.

* While the increase in virus cases and accompanying restrictions impacted Apr and May’21, the rebound in Jun’21 (monthly run-rate of INR7.9b) should reassure investors of its ability to weather the impact owing to its business and geographical diversification. With the situation expected to further ease out over the next few months, we expect SIS to deliver 12% revenue CAGR over FY21-23E.

* We continue to see an uptick in growth in the India business (Security and Facilities Management) in FY22E, and estimate 17% CAGR in the India Security/Facilities Management business over FY21-23E. We continue to build in 7% CAGR in the Australia business over the next two years as an expected reduction in the ad hoc business should partially depress recovery in the normal business.

* SIS should reverse a large portion of the margin impact of the past two quarters as higher revenue growth and absence of COVID-related costs should act as levers to subdued margin. With growth returning in FY22, a major portion of the drag in Facilities Management should also go away.

* We see a gradual improvement in margin and expect a 20bp increase over FY21-23E. The positive operating leverage in the India business should more than compensate for the expected moderation in margin in the international business, which benefitted from the ad hoc business in FY21.

* We expect cash conversion to moderate in FY22 as the India business returns to growth, increasing overall DSO. We also expect significantly lower net debt/EBITDA for the company as all major payouts are now over.

* Given the multi-dimensional opportunity, we value SIS at INR600/share (24% upside), derived by assigning an 8x forward EV/EBITDA multiple to the International business (in line with its global peers) and DCF to the India business.

Operations below our estimates on muted performance in the international business

* Revenue increased by 10% YoY (est. +13%), EBITDA was flat YoY (est. +13%), while adjusted PAT declined by 9% (est. +19%).

* Revenue rose by 9.8% YoY, but fell by 2.7% QoQ to INR23.8b (3% miss).

* The revenue decline was attributable to: a) 4.2% QoQ fall in the international business (due to tapering in ad hoc revenue), and b) 2.3% decline in the India Security business (in line with our expectations). The Facilities Management business posted moderate growth (3.1% QoQ).

* All businesses reported higher revenue in Jun’21 vis-à-vis Apr-May’21, indicating the start of a business recovery.

* EBITDA margin was flat QoQ, but down 50bp YoY (below our expectations), at 5.1%.

* The drop in margin was majorly weighed by a reduction in the high-margin ad hoc business in Australia, leading to 50bp sequential decline in the International business. Margin in the India business remained flat, while that for the Facilities Management business increased 240bp on a lower base.

* Consolidated PAT stood at INR528m, implying a YoY decline of 8.8%. This was attributable to lower operating income and other income.

* During 1QFY22, the company recognized grants of INR67m from the Singapore government.

* Net debt stood at INR6b (against INR3.7b in 4QFY21), implying a net debt/EBITDA of 1.15 (v/s 0.72 in 4QFY21).

* The increase in net debt was due to significant cash outflows on account of: a) balance stake purchase in Henderson and Uniq INR1.7b, and b) buybacks of INR1.2b (including tax). The total cash outflow stood at INR3b.

* OCF/EBITDA stood at 95.5% in 1QFY22. The company generated a total OCF of INR1.2b in 1QFY22.

* The international business returned INR500m to parent SIS in the form of dividends in 1QFY22.

Key highlights from the management commentary

* The dip in the international business was on account of normalization of revenue and margin to pre-COVID levels after a record performance in FY21. The ad hoc business will gradually taper off over the next two quarters. However, the decline will be compensated by growth in the regular business.

* Within the India business, Apr-May’21 had been impacted by the second wave of COVID-related lockdowns. It started seeing a recovery from Jun’21. This has impacted the recovery in margin.

* The India Security business is back to pre-COVID levels, while the Facilities Management near to a complete recovery and is expected to be the biggest winner among all segments.

* SIS is looking to double its market share in Security, Facilities Management, and Cash Logistics over the next 4-5 years.

* The management guided at margin to be in the 5.7-6% range.

Valuation and view

* Over the medium term, as both the Central and State governments look to liberalize and formalize the labor markets, SIS should be among the biggest direct beneficiaries.

* We value SIS at INR600/share using SoTP valuation: 1) DCF for the India Security business (INR335/share), 2) EV/EBITDA multiple of 8x (INR156/share) for the International Security business (in line with global peers), and 3) DCF for the Facilities Management business (INR116/share). We arrive at our TP of INR600 per share.

* Our TP implies a target P/E multiple of ~29x/21x for FY22E/FY23E. We view this as reasonable, given its strong growth profile and unique resilience to macroeconomic shocks.

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