IGI Logo

Growth/margin headwinds continue

Sonata Software (Sonata) reported IITS (international IT services) revenue at US$56.8mn (+3.9% QoQ CC, 2% QoQ USD, lower than our estimate of 3.5% QoQ USD). The modest revenue growth during the quarter was due to project-specific delays and talent-supply constraints. Managed cloud services (+5.6% QoQ USD), ‘modern validation and dev eng mgmt ser’ (+5.1% QoQ USD) and IMS (+3.2% QoQ USD) grew at healthy rates. Growth in Microsoft digital platform services (+2.2% QoQ USD) and Microsoft dynamic services (+0.7% QoQ USD) was soft. In terms of verticals, growth was driven by ISV (+4.5% QoQ USD) while the rest were tepid. Management said deal wins and deal pipeline continue to be healthy.

Segmental EBITDA margin in the IITS business further shrank to 26.6% (-91bps QoQ / -340bps YoY) led by supply-side challenges and wage increments for senior management in Q1FY23. Wage hikes for FY23 will be in Q4FY23 for majority of the employees. Company will continue to invest in its leadership team, sales and pre- sales teams and development centres in Canada, Mexico and Ireland. Sonata IT services headcount addition was low at 1% QoQ. Company plans to induct 600 freshers over Q2 and Q3 this year. Due to continued supply-side pressures,
investment in sales and reversal of covid-induced cost savings, we expect margins to remain muted in the IITS business in FY23.

DPS (domestic products business) continued to surge at a strong rate of 42% YoY. Revenue from this segment has grown at 9% CQGR for the past four quarters led by sturdy growth in annuity and cloud services. Company continues to focus on growing cloud-led revenue across three major hyperscalars in the domestic market. However, share of cloud-led revenue dipped 200bps QoQ to 76%, post consistent growth in the past eight quarters. Annuity revenue remained stable at 76%.

We continue to value Sonata at 15x on FY24E EPS of Rs45 to arrive at a revised target price of Rs673 [prior:689]. The stock is currently trading at 18x / 15x on FY23E / FY24E with revenue/EPS CAGRs of 14% / 11% over FY22-FY24E. Maintain HOLD.

* Colour on IITS business growth. Sonata reported IITS (international IT services) revenue at US$56.8mn (+3.9% QoQ CC, 2% QoQ USD, lower than our estimate of 3.5% QoQ USD). Growth was led by digital and ‘platformation’ services. Share of digital revenue remained steady at 73% and ‘platformation’ at 25%. Management said deal wins and deal pipeline continue to be healthy.

By service line, managed cloud services (+5.6% QoQ USD), ‘modern validation and dev eng mgmt ser’ (+5.1% QoQ USD) and IMS (+3.2% QoQ USD) grew at healthy rates. Growth in Microsoft digital platform services (+2.2% QoQ USD) and Microsoft dynamic services (+0.7% QoQ USD) was soft during the quarter.

In terms of verticals, growth was driven by ISV (+4.5% QoQ USD) while the rest reported soft growth. Distribution & manufacturing grew 2.5% QoQ, retail (essential) 2% QoQ, retail (non-essential) and commodities and other services growth was flat QoQ. Travel declined 1% QoQ. In retail there is good traction post return of footfalls in traditional brick and mortar retailers. Travel vertical has recovered to pre-covid levels but, since the nature of engagement has changed in terms of shift to offshore, absolute revenue has reduced.

* IITS margins expected to remain under pressure. Consolidated EBITDA came in at 8% (+60bps QoQ). However, segmental EBITDA margin the IITS business further declined to 26.6% (-91bpsQoQ, -340bpsYoY) due to supply-side challenges and wage increments for senior management in Q1FY23. EBITDA margin in DPS was healthy at 3.3% (+50bps QoQ, -10bps YoY).

* Strengthening senior leadership team. Post appointment of new CEO, Mr. Samir Dhir, on 8th Apr’22, Sonata is investing in strengthening its senior leadership. Company appointed Mr. Roshan Shetty as chief revenue officer, responsible for sales of its services business, based out of the UK. Mr. Roshan brings to Sonata over two decades of global experience in the IT services industry. Prior to Sonata, he was with Infosys as head of insurance, life-sciences and healthcare for EMEA in addition to being UK head and member of executive council (Europe) Sonata appointed Mr. Balaji Kumar as chief (human resources), responsible for the HR function globally. Previously, Mr. Balaji was the chief (human resources officer) globally at L&T Infotech.

* Bonus issue of share. The Board approved a bonus issue of 1 (one) equity share for every 3 (three) held by the shareholders. Rs35mn will be required from the share premium account for implementing the bonus issue.

To Read Complete Report & Disclaimer Click Here

For More ICICI Securities Disclaimer https://www.icicisecurities.com/AboutUs.aspx?About=7

SEBI Registration Number INZ000183631

Above views are of the author and not of the website kindly read disclaimer