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Defying the gravity

Tata Elxsi (TELX) is a consistently strong performer achieving >6% QoQ CC growth (with sustained margin expansion) for eight consecutive quarters. Its Q1FY23 revenue growth was strong at 6.5% QoQ CC (I-Sec: 5% QoQ CC). Growth was volume-led and driven by transportation (+7.8% QoQ CC) and healthcare (+7.4% QoQ CC) while media & communications grew below company average at 3.7% QoQ CC.

Company’s Q1FY23 EBITDA margin at 32.8% (+30bps QoQ) was a strong beat on our estimate of 30% despite wage hike for senior employees during the quarter. The resilient margin performance was led by improved utilisation, pyramid balancing, price hikes in certain projects and revenue growth leverage. Employee cost as % of revenues was stable at 50.4% (-20bps QoQ). Management mentioned offshore mix is likely to remain in the 73-75% range in the near-term vs current 74.9% (-30bps QoQ) in Q1FY23. Attrition declined 180bps QoQ to 19% indicating stabilising trend. Company has a fresher addition target of 3k-3.5k for FY23. We expect margins to reverse from current elevated levels over the medium term. However, near-term margins are likely to stay around 31-32% supported by high offshore levels, stabilising attrition and pyramid balancing. We build-in an EBITDA margin of 30.1%/28.8% for FY23E/FY24E.

Management mentioned it is not witnessing any reductions in clients’ R&D budgets as of now. Company’s order book and pipeline remain strong. Net headcount addition too was healthy at 771 (+8% QoQ) vs average net addition of ~504 per quarter in FY22. We note ER&D spends tend to be more discretionary in nature compared to IT services and are likely to be impacted more by potential global slowdown/recession. Management said in case of recession and budget cuts, impact on TELX is likely to be less than that on the industry because the company operates at competitive rates enabled by its high offshore presence and the critical strategic client projects on which it is working. We expect TELX to grow at 24%/15.3% in FY23E/FY24E, which would be higher than the industry growth rate.

Company 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 sustenance of margin way above pre-covid levels. We increase our EPS estimates by 13.5%/12% led by increase in margin estimates. We are above consensus earnings by 15% for FY24E. However, the company’s super premium valuations of 66x/60x EPS of Rs122/134 for FY23/24 drive our SELL rating. We value TELX at 40x the target multiple of FY24E earnings to arrive at a fair value of Rs5,373 (earlier: Rs4,557).

Revenue above estimates.

Revenues for the quarter came in at Rs7,259mn (+6.5% QoQ CC vs our estimate of 5% QoQ CC). Embedded product design (89% of revenues) reported growth of 6% QoQ CC. This was on top of strong growth in last four quarters (average 8.5% QoQ CC). Within EPD, growth across verticals was led by transportation (+7.8% QoQ CC) and healthcare (+7.4% QoQ CC). Healthcare has grown 3x in the past two years and now accounts for 15% of EPD revenues (on track to reach 20% within the next two years). Media & communications segment growth at 3.7% QoQ CC was below the company average.

Industrial design & visualisation segment reported robust growth of 9.3% QoQ CC led by design and AR/VR deals. System integration & support (SIS) grew 19.4% QoQ CC post decline in the past two quarters. SIS growth comes from India region where TELX works with captive MNCs.

In terms of markets, US (8.2% QoQ USD) led growth. Growth in Europe was soft at 0.8% QoQ USD due to cross-currency headwinds. India revenues grew 13.6% while RoW declined -22.2%, QoQ USD, led by weakness in China (covid lockdowns and supply chain issues) and weak macro-economic environment in Japan and Korea. Top-5 clients reported robust growth of 8.7% while top 6-10 accounts grew 9%, QoQ USD.

Strong orderbook and pipeline remain healthy:

Company’s orderbook is strong with key wins in Q1FY23, including: 1) a multi-year multi-million-dollar deal from global tier-1 supplier for next-gen e-powertrain development; 2) a multi-million-dollar deal win from an automotive OEM in APAC and deals in areas of new-gen technologies such as smart network operations, adtech, augmented realty, etc. Management stated the deal pipeline is robust and provides confidence for strong growth in the near term.

Healthcare platform T-engage

launched in Mar’22 is gaining good traction. Based on capabilities showcased via the platform, TELX is winning projects that address customised healthcare platform services for clients. However, for its own platform it has not seen much wins as it is still in an early stage.

Resilient margin performance:

Company reported strong beat on margins at 32.8% (+30bps QoQ) vs our estimate of 28% despite wage hike for senior employees during the quarter. The resilient margin performance was led by improved utilisation, pyramid balancing, price hikes in certain projects and revenue growth leverage. Employee cost as % of revenues was stable at 50.4% (-20bps QoQ). Management said offshore mix is likely to remain in the 73-75% range in the near term vs 74.9% (-30bps QoQ) in Q1FY23. Attrition declined by 180bps QoQ to 19% indicating stabilising trend.

TELX could get price increases on certain customers with whom it has engaged over a longer term, based on the value that it brings for them.

Strong hiring continues:

Hiring was strong with net addition for the quarter at 771, (+8% QoQ vs average net addition of ~504 per quarter in FY22). Company is aggressively investing in accelerated hiring of freshers and laterals. It has fresher addition target for ~3k-3.5k and ~1k-15k of lateral hires for FY23.

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