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Execution challenges mar quarter

Sterlite Technologies (Sterlite) reported weak Q3FY22 results due to execution challenges in the UK services business and a one-off provision in domestic services. Order book is strong, but a conducive external environment is necessary for its translation to revenue.

We believe the products business will continue to see strong traction considering rising demand for digital connectivity. The company is also seeing good adoption of optical interconnect products. However, considering the execution challenges in the services business, we are slashing FY23 earnings estimate by 21% and cutting the target multiple from 20x to 18x. Retain ‘BUY’ with a revised TP of INR302 (INR386 earlier).

Weak results; strong order book drives confidence

Sterlite’s revenues declined 10.1% QoQ, well below Street’s estimate of 4.2% growth. There was an overall provision impact of INR0.63bn on revenue and INR1.8bn on other costs (total impact of INR2bn on profitability). Apart from the provisions, margins were impacted by a change in system integration project mix and additional investment in growth areas. EBITDA margin slid by 2,110bp QoQ to -3.7%, again well below Street’s estimate of 16.4% (12% on like-to-like basis). Order book expanded again, to INR117bn, from INR115bn in Q2FY22, 52% of which is executable FY24 and beyond. In terms of revenue contribution, telcos contributed to 74% in 9MFY22 compared with 64% in 9MFY21. By geography, contributions from the US and EMEA increased substantially YoY.

Some volatility expected; overall demand story intact

While the overall demand story is intact, considering that the company is still ramping up project execution capabilities and the inherent lumpiness in the business, profitability might be a volatile affair for the company. This coupled with customer-specific issues, like the one in the current quarter, might further affect quarterly growth. While we do expect profitability to stabilize in the long run, such bouts of volatility cannot be ruled out in this kind of business.

Outlook and valuation:

Blip in growth; retain ‘BUY’ We are reducing FY22/FY23 EPS estimate by 63%/21% to factor in execution challenges and heightened investments. The stock is trading at an attractive 16.2x FY23E EPS. Maintain ‘BUY/SO’ with a revised TP of INR302 (from INR386) while reducing our target to 18x and rolling forward the valuation to Q1FY24E.

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