Buy Sonata Software Ltd For Target Rs.880 - Anand Rathi Share and Stock Brokers
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Steady growth in Q1, margins show resilience; maintaining a Buy
Sonata’s IT services revenue was $57m (TTM $215m), up 2% q/q (4% cc), 19% y/y organic (28% reported). Headcount (up 23% y/y) addition was just 36 as ~600 freshers will join in Q2/Q3. The margin was 22.4%, down 63bps q/q absorbing management costs, wage hikes and cross-currency. The margin outlook was more positive due to growth and rupee depreciation, and despite sales hiring ahead. The India business delivered high growth. No meaningful change in estimates; target revised to Rs880 (from Rs.1,020), 18x FY24e, reflecting Europe/Retail/Mfg dependence.
IT services growth driven by Hi-tech, Healthcare.
Hi-Tech/ISV contribute 33.2% to IT services and is seeing growth acceleration in the last two quarters. In Q1 FY23, it delivered 4% q/q growth. Besides, Healthcare (4% of IT services), though on a small base, grew 10% q/q. Retail also grew but at the company average with management not anticipating weakness in this vertical now. Travel declined 1% q/q mostly on European currency billing. US sequential growth was slow compared to peers; new leadership hired for acceleration.
IT services margins at upper end of 20-22% guidance
IT services’ Q1 EBITDA margin was 22.4%, (down 63bps q/q, but y/y up 113bps), absorbing the impact of the balance wage hikes and other sales/management-related costs. The wage hikes are scheduled in Q4 and attrition has already started coming off the peak. Management spoke about more senior management and sales hiring ahead but, given the tailwinds, should stay on course in terms of margin trajectories. Hence, we retain our margin estimates. Utilisation to be a little lower ahead as freshers join over the next two quarters.
Target revised to Rs880; retaining a Buy
Sonata’s IT business is likely to clock a 17% CAGR, with margins expected to contract to ~21.3% (FY22 23.4%, Q1 22.4%), both largely unchanged. In its India business, Sonata is likely to record a 21% EBITDA CAGR, taking the consolidated FY24e EPS to Rs49. The stock trades at 14x FY24e EPS (6% FCF yield), which we find attractive. Risk: Supply-side challenges.
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