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L&T Technology Services’ (LTTS) Q2FY23 revenue growth at 4.5% QoQ CC beat our estimate of 4%. The growth was led by transportation (9.4% QoQ CC) and plant engineering (6% QoQ CC) verticals. However, the company continued to witness tightening of budgets in the medical devices segment and pauses in the sub-verticals of hi-tech and telecom.

Management has narrowed its revenue growth guidance band to 15.5-16.5% YoY CC for FY23 (vs 14.5-16.5% earlier). The guidance implies soft revenue growth of 0.6-1.8% QoQ CC in the next two quarters (Q3, Q4) and factors-in the potential impact of macro headwinds apart from furloughs in Q3FY23 in our view. We model 13% YoY USD growth for FY23E.

LTTS won one US$60mn and one US$10 mn deal this quarter. We note that deals worth >US$10mn were lower in Q2FY23 vs 4-7 such deals in the past few quarters. Large deals are being driven by the transportation segment wherein LTTS won large deals of size US$60mn in Q2FY23, US$50mn in Q1FY23 and US$120mn in Q4FY22. Management mentioned that the deal pipeline has grown on both YoY and QoQ basis. However, muted headcount addition (just did 107 net-addition in billable headcount) and implied weak guidance for H2FY23 indicate an understandably cautious management stance in view of the macro headwinds. Sales & Support headcount also declined by 5% QoQ. Growth in revenue and employee addition move in tandem (chart 1) while softening headcount addition indicates softening demand.

Management retained its long-term revenue guidance of achieving US$1.5bn revenue run-rate by FY25. We believe this is a stretched target and difficult to achieve organically in just two years given the macro challenges.

LTTS maintained its EBIT margin at >18% despite headwinds from wage hikes in Q2FY23. EBIT margin came in at 18.2% (-10bps QoQ) above our estimate of 17% as headwinds from wage hikes were offset by tailwinds from revenue growth, ‘higher quality of revenue’ (i.e. higher growth from more profitable segments) and INR depreciation. Management expects to maintain margins above 18%. Going forward, attrition is likely to normalise and thus reduce wage inflation pressures. Sales and support headcount reduced by 4.9% QoQ, partly led by rationalisation in G&A costs.

We increase our EPS estimates by 1.6 / 1.7% for FY23E / FY24E due to the beat on margins in Q2FY23, and changes in FX assumptions partially offset by reduction in USD revenue growth estimates. LTTS trades at valuations of 34x / 29x for FY23E / FY24E. We continue value the stock at 25x on FY24E EPS of Rs 125 to arrive at a target price of Rs3,132. While LTTS is well positioned to play the ER&D theme, we do not find the riskreward favourable. In our view, ER&D spends are project-based and done for future growth agendas, hence more discretionary in nature compared to IT services. These spends are likely to get delayed in case of slowdown/ recession. Maintain REDUCE

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