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Growth to remain strong; margin recovery to drive earnings

Valuations remain favorable; reiterate BUY

* SIS reported an in-line performance in 2QFY24. Its revenue increased 11.1% YoY, while its EBITDA margin stood at 4.7%. Despite a weak macro environment, SIS delivered healthy growth in 2QFY24. The management commentary remained strong, suggesting robust growth in 2HFY24 aided by strong order book. Cross-selling opportunities in India Security and Facility Management (FM) businesses, coupled with an increase in minimum wages and long-term tailwinds from sector consolidation, are expected to position SIS for a 13.4% revenue CAGR (MOSLe) over FY23-25.

* India Security/FM businesses are likely to deliver a strong revenue CAGR of 19%/18% for FY23-25. Conversely, its Australia business is anticipated to report a modest 6.8% CAGR over the next two years.

* After recording a strong improvement in 1QFY24, the margin uptrend continued for the India Security business. Margin improved 70bp over the last two quarters, which is promising. Though FM posted a 40bp sequential margin decline, management is adopting a similar margin improvement approach for the FM business by rationalizing its low-margin accounts. The management expects a gradual margin recovery in the FM business. With stabilization in SG&A costs and strong growth ahead, SIS anticipates to return to the pre-Covid level margin (of ~6%) in its India Security and FM businesses. We expect an overall margin of 4.8%/5.3% for FY24/FY25. The company is likely to return to FY21-level margin in the medium term, backed by healthy operating leverage in its India business and stable performance in its international business.

* We have largely maintained our EPS estimates aided by the stable quarter. Given the multi-dimensional opportunity, we value SIS at INR490/share (19% potential upside), derived by assigning 8x forward EV/EBITDA multiple to International business (in line with global peers) and DCF to the India business. We reiterate our BUY rating on the stock.

Operating performance in line

* SIS’s revenue increased 11.1% YoY and 3% QoQ to ~INR30.7b in 2QFY24, in line with our expectations.

* Sequential revenue growth was led by ~6% QoQ growth in India Security. FM business rose 1.7% QoQ while International security grew 1.3% QoQ.

* EBITDA margin, at 4.7%, was flat QoQ (in line with our estimate of 4.6%).

* Consolidated adj. PAT stood at INR753m (+12% YoY; in line). Tax rate was higher at 16% vs. 5% estimated.

* Net debt increased to INR10.5b. Net debt/EBITDA was at 1.9x. OCF/EBITDA conversion was weak at 2.3% in 2QFY24.

Key highlights from the management commentary

* During Covid-19, as FM business was hit, SIS had to take up several low-margin contracts. Currently, the FM business is under a portfolio review exercise to identify and fix the low-margin contracts. These contracts are either negotiated for re-pricing or replaced with better-margin contracts.

* VProtect continues to see strong traction and has an order book of over 5k. Tech SIS is expected to deliver one of its best years backed by a strong order book. Currently, 8-10% of its security business revenue comes from solutions. For the FM segment, solutions business contributes as much as 30% to revenue.

* Management suggested a strong 2HFY24 aided by a strong order book. It is confident of restoring EBITDA margins for all businesses to the pre-Covid levels.

Strong and resilient growth profile to drive further upside; reiterate BUY

* With the liberalization and formalization of labor markets and laws, SIS should be among the biggest direct beneficiaries. SIS has managed to gain market share during the last few years, and the trend is expected to continue.

* We value SIS by using an SoTP method: 1) DCF for the India Security business (INR347), 2) an EV/EBITDA multiple of 8x (INR116) for the International Security business (in line with global peers), and 3) DCF for the FM business (INR100) less net debt (INR71). Consequently, we arrive at our TP of INR490. We reiterate our BUY rating on the stock.

* Our TP implies a target P/E multiple of 12x for FY25E. We view this as reasonable, given its strong growth profile and unique resilience to macro shocks.

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