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Premium performance < Super premium valuations

Tata Elxsi (TELX) reported strong revenue growth of 7.3% QoQ US$ (7.4% QoQ CC) in 4QFY22, representing a beat to our estimate of +6.0% US$ QoQ. Growth was broad-based across verticals: transportation (+8.3% QoQ CC) led the pack, followed by media (+7.2% QoQ CC) and healthcare (+6.8% QoQ CC).

Margin performance was resilient at 32.5% (-70bps QoQ) vs Isec estimate of 31.9%; the slight beat was largely on account of lower employee expenses at 51% of revenue – lowest-ever – which led to gross margin of 44.5% in Q4FY22. Margin is unlikely to expand further given the supply-side challenges due to high attrition, reversal of elevated offshore mix (75.2% in Q4FY22 vs 55-57% pre-covid), peakedout utilisation and return of travel and facility costs post the normalisation of global economy. However, we expect margin to stabilise above pre-covid levels (~24%) due to greater acceptability of clients toward offshoring and supported by levers of revenue growth leverage and pyramid optimisation. We build in EBITDA margin of 28.3%/27.5% for FY23E/FY24E.

TELX has emerged the fastest-growing company among Indian ER&D peers, growing at 9% YoY in FY21 and 34% YoY in FY22. We expect revenue growth leadership of TELX to continue over FY23E-24E driven by 1) higher offshore R&D spends on digital, 2) strong client mining capabilities (top 1 / top 5 clients grew 57%/40% YoY in FY22), 3) focus on winning longer-duration larger sized deals by becoming strategic partners for clients (e.g. Aesculap and Schaeffler deal wins), and 4) expansion in fast-growing healthcare sector and diversification in auto to derisk growth. We expect TELX to continue its growth momentum and forecast revenue growth of 26%/23% in FY23/FY24.

TELX has superior operating metrics compared to its peers: 1) lowest cost of delivery; 2) highest offshore mix; 3) reducing client concentration and, at the same time, superior client mining capabilities. We like the company for its robust growth profile and maintenance of margin way above pre-covid levels. We are above consensus earnings estimates by 10% for FY24. However, its super premium valuations of 74.5x/61.3x on EPS of Rs106/129 drive our SELL rating. We value TELX on 38x target multiple of FY24E earnings to arrive at a fair value of Rs4,902 (prior: Rs4,875). Key upside risk to our rating includes better than expected margin performance.

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