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Expensive valuation; a choppy ride ahead

Tata Elxsi (TELX) is a leading provider of IT ER&D (engineering, research and development) services. TELX has capabilities across Automotive, Broadcast & Communications, and Healthcare Industries.

* Q2FY23 revenue grew by 28.2% YoY to Rs. 763cr. (5.1% QoQ) and PAT grew by 39.2% YoY (-5.5% QoQ), driven by strong 29.0% YoY (3.1% QoQ) Constant Currency growth in EPD (Embedded product design).

* However, TELX’s EBIT margin contracted by 180bpsYoY (-313bps QoQ )due to campus recruitment, training & development and operationalisation & expansion of the facility for people to come back to the office.

* Considering the demand and robust outlook, management plans to hire total of 4000-5000 employees in FY23. Net employee addition for H2FY23 stands at 2303 employees.

* While supply side issues continue to be a problem for near term to ramp up new projects. In addition, company reiterated that, Global uncertainties in Europe are cautiously watched and the customers have shown some deferment in the new projects of communication and media.

* At CMP the TELX’s is trading at 63x on a 1Yr.fwd basis, which is expensive comparing to its historical avg. Considering the near term headwind on margins, we downgrade our previous rating from Reduce to Sell with a target price of Rs. 7,524 (50x FY24E EPS).

Supply side issues to drag margin for short term.

During Q2FY23, TELX’s revenue grew 30.0 YoY to Rs. 763 Cr (6.5% QoQ). EPD - company’s largest division, grew by 29.0% YoY CC and SIS (System integration & support) division grew by 15.4% CC, and IDV (Industrial design and visualization) grew by 41.7% YoY CC. PAT growth was 39% YoY. On the margin side, EBIT margin contracted by 180bps YoY due to campus recruitment, training & development and operationalisation & expansion of the facility for people to come back to the office. Total headcount stood at 11,679 as of Q2FY23 end. Employee net addition was 1532, nearly doubled from the previous quarter. Management plans to add 4,000-5,000 headcounts in FY23. Unlike the industry trend, attrition rate was 18.7%, down by 30bps QoQ. The salary hike was already completed over January and April. Company’s effective tax rate has come down to 19%, supported by the expansion of office capacity in Trivandrum SEZ (Special Economic Zone) and 40bps improvement in top-line for cross currency.

Deferment in some new projects.

On a Constant curreny terms, all three verticals of EPD division reported strong growth. Transportation vertical (contributing 41.5% of total revenue) grew by 4.6% QoQ, and Healthcare & Medical Devices (Contributing 15.4% of total revenue) reported 5.1%. However, Media & Communication vertical (contributing 43.1% of total revenue) grew by marginal 1% QoQ due to deferment of some new projects, Company’s Onsite-offshore mix was reported at 24.8%-74.9% helping TELX to maintain high margins. While, TELX’s revenue contribution from India declined by 140bps due to re-routing the supply to offshore projects.

Strong deal momentum and new strategic partnerships.

As per the management commentary, the business outlook continues to be strong for transportation, with multi million dollar win from leading automotive company in Autonomous and vehicle connectivity and infotainment. Despite the global headwinds , company’s hiring plan to continuous to be strong, with a blend of fresher’s and lateral employees, which will be ready in the next 6 months for newer projects developments in Transport, Medical and Media.

Outlook and valuation

We expect less impact on the company even in the case of global slowdown, as TELX work on client’s long term strategic projects. Considering the positives, we expect the top line to grow at 26% CAGR and bottom line to report a growth of 40% CAGR over FY22-24E. However, we believe a near term headwinds cannot be ruled out and the positives are already built in the valuation as stock trades at expensive valuation of 63x (1Yr Fwd. P/E). Hence, we value the stock at 50x(5Yr. Historical Avg.) FY24E EPS and downgrade our previous Reduce rating to Sell with a target price of Rs. 7,524.

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