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International business faces short-term hurdles

* SIS (SECIS)’s 2QFY25 revenue was up 6.3% YoY/4.4% QoQ at INR32.68b, largely in line with our estimate of INR34.51b. Growth was led by Security Solutions – International business (up 5.6% QoQ/7.0% YoY). EBITDA margin came in at 4.4% (vs. est. 5.0%), down 30bp YoY. Margin for India Security contracted 20bp YoY to 5.5%, while the same for International Business contracted 70bp YoY due to the loss of certain high-margin contracts during the previous year.

* Consolidated adj. PAT stood at INR688m (down 8.6% YoY), below our estimate of INR1,161m, on account of higher ETR and interest expense. For 1HFY25, revenue grew 5.8% while EBITDA/PAT declined 0.5%/19.3% vs. 1HFY24. We expect revenue/EBITDA/PAT to grow 12.4%/42.8%/8.8x YoY (owing to low base) in 2HFY25. We reiterate our BUY rating on the stock with a TP of INR480, implying 25% potential upside.

* SECIS witnessed decent growth across all segments this quarter. The India Security business was up 6.3% YoY in 2Q and is expected to sustain its growth momentum, with guidance for mid-teens organic growth. Consistent deal wins in sectors such as Transportation, Logistics, and BFSI provide a stable growth foundation; however, profitability remains under pressure as SECIS's price growth has been limited due to wage hikes, with the company still aiming to return to pre-COVID margin levels of 6%. We expect the Indian business to clock a revenue CAGR of 13% over FY24-27.

* Additionally, Its International business, particularly the Australian business, is still under pressure and could post a modest 6.4% CAGR over FY24-27. Management expects turbulence in its International business in the near term, particularly in Australia.

* Margins: The margin contraction in 1QFY25 (-30bp YoY) was due to the International business (-60bp YoY) facing labor shortages, loss of highmargin contracts, and high labor costs. These trends are expected to continue in the short term, with higher wage costs and labor issues likely to take a couple of quarters to resolve in Australia. The International business is projected to have a ~3.9%-4.5% margin, while the FM business margin is expected to inch up towards 5.0%.

*  Management aims to expand the EBITDA margin by focusing on rationalizing loss-making/tail accounts and SG&A rationalization. We expect overall margins at 4.6%/4.9/5.2% in FY25E/26E/27E.

* We trim our EPS by ~8-9% to factor in ongoing pressure in the Australian business and lower profitability in Security Solutions – India Business. We value SECIS at INR480 (25% potential upside), assigning an 8x forward EV/EBITDA multiple to its international business (in line with global peers) and DCF to its Indian business. We reiterate our BUY rating on the stock.

In-line revenues and margins

* SECIS’s revenue grew 6.3% YoY/4.4% QoQ at ~INR32.68b vs. our est. of INR34.51b.

* Revenue growth was aided by ~6.3% YoY growth in India Security, whereas Facility Management/International Security posted a modest growth of 4.8%/ 3.2% YoY.

* EBITDA margin came in at 4.4%, down 30bp YoY (vs. est. 5.0%). Margin for India Security contracted 20bp YoY to 5.5%, while the same for International Business contracted 70bp YoY.

* Consolidated adj. PAT stood at IN688m (down 8.6% YoY). On a standalone basis, SECIS’s current tax rate continues to be close to NIL due to the benefits accruing under Section 80JJAA of the Income Tax Act, 1961.

* Net debt amounted to INR8.6b from INR10.2b in 1QFY25. Net debt/EBITDA stood at 1.4x vs. 1.7x in 1QFY25.

* OCF/EBITDA conversion was 166.1% owing to better working capital management.

Key highlights from the management commentary

* Revenue stood at INR32.68b, up 6.4% YoY. Growth was observed across all three segments. There are no M&A activities at an advanced stage; organic growth remains the key driver.

* Australia and India have a strong order book lined up for the 2H.

* Security Solutions – India noted margin expansion QoQ despite the full impact of annual salary revisions for back-office employees effective Jun’24, supported by focused margin management initiatives.

* The company expects mid-teens organic growth in the India Security business.

* Security Solutions – International: EBITDA margin for Q2 FY25 was 3.3%, slightly down from 3.4% in Q1 FY25, marginally impacted by the 3.75% minimum wage revision by Fair Work Australia effective July 1st .

* The Singapore acquisition is performing well, with the business at breakeven and cash/bank balances exceeding USD20m, though it remains a small part of the SECIS ecosystem.

* Net Debt/EBITDA was 1.47x at the end of 2QFY25, down from 1.76x at the end of 1QFY25, driven by the repayment of certain long-term debts and improved working capital management.

Valuation and view

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

* We value SECIS using SOTP: 1) DCF for the India Security business (INR291), 2) an EV/EBITDA multiple of 8x (INR130) for the International Security business (in line with global peers), and 3) DCF for the FM business (INR113) less net debt (INR106). Consequently, we arrive at our TP of INR480. We reiterate our BUY rating on the stock.

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