IGI Logo

Margin beat; near-term growth challenges persist

Sonata reported a better-than-expected operating performance on margin beat. IITS revenue grew 0.2% QoQ to USD82mn (1% CC), in line with our expectations. Revenue growth was lopsided, with RMD driving growth while the rest of the verticals either reported muted revenue or decline on a sequential basis. IITS EBITDAM rose by 70bps QoQ to 17.3%, above our expectations, despite the wage hike. Sonata reported order bookings of USD105mn (10% were AI-led) and a book-to-bill ratio of 1.28x. Revenue growth was impacted by the continued ramp-down of a large BFSI client due to budget constraints, softness in the largest TMT client account, and domestic SITL headwinds, though partially offset by ramp-ups in large HLS and TMT deals and mid-sized AI wins. Despite the second phase of wage hike for mid-to-senior employees in Q3, the management expects IITS EBITDAM recovery to sustain in H2 on operating efficiencies, driven by higher utilization, offshore shift, pyramid rationalization, and AI-led productivity improvement. The company aspires to operate at a high-teen EBITDAM in the near term and aims for low twenties in the medium term. The management expects profit growth in H2 vs H1. Factoring in the Q2 performance and near-term growth challenges, we tweaked our FY26- 28E EPS by -5% to 4%. We retain BUY, with an unchanged TP of Rs400, at 18x Sep-27E EPS.

Results Summary

IITS revenue grew 0.2% QoQ to USD82mn (1% CC), in line with our estimate. IITS revenue performance was skewed, driven by RMD (up 10.3% QoQ, aided by certain one-offs), while the other verticals reported either muted revenue or decline QoQ (Emerging 24.8%, BFSI 4.8%, TMT 2.9%, HLS flattish). Among geographies, the US declined 6.5% QoQ, while Europe/the RoW grew 12.8%/30.3%, respectively. IITS EBITDAM rose by 70bps QoQ to 17.3% on operating efficiencies, led by utilization, offshore shift, delivery efficiencies, and currency benefits (+160bps) negating the wage hike (-90bps). Overall EBITDAM grew by 280bps QoQ to 8.1%. IITS headcount fell 4.0% QoQ to 6,136. Gross contribution grew 0.3% QoQ in the domestic business. Sonata declared an interim dividend of Rs1.25/sh. What we like: Margin beat, steady deal intake. What we do not like: Revenue miss, continued client-specific issues in BFSI and TMT.

Earnings Call KTAs

1) Headwinds from the largest BFSI client, driven by organizational changes and budget constraints, impacted BFSI growth in Q2, with a residual impact expected in Q3 before growth resumes in the vertical. 2) In TMT, softness in the largest client account was partly offset by traction among smaller and mid-sized tech accounts. 3) The company also won a major multi-year large deal in Q2 from a leading US healthcare provider to modernize core platforms using automation and A 4) RMD growth rebounded in Q3, largely on the back of certain one-offs. Excluding one-offs, performance remained muted due to industry-wide slowdowns and tariff-related challenges; however, the management expects stabilization and a return to growth within two to three quarters. 5) The company aims to scale up HLS and BFSI verticals to USD250mn revenue in 3-5 years. 6) The mgmt highlighted that Sonata continues to benefit from three tailwinds: i) large TMT and healthcare deals ramping up with wider scopes, ii) HLS and BFSI seeing healthy demand, supported by data-led and AI-led wins, iii) operational efficiency improving through higher utilization (87.3% in Q2 vs 86.6% in Q1), planned offshoring (57% in Q2 vs 53% in Q1), and greater AI and agentic adoption. 7) It noted that large deals remain central to the company’s strategy, representing ~40% of the pipeline, with 28 large deals (RMD:14, TMT:7, BFSI:5, HLS:2) in the pipeline (expected to take around 4-6 quarters to close). 8) Overall, the pipeline is heavily geared toward modernization, with cloud and data initiatives accounting for ~55% of total opportunities. 9) AI momentum continues to build, with AI-led deal pipeline of ~USD293mn in Q2 and an AI order book of USD10.8mn. The AI order book grew from 8% to 10% of the overall order book sequentially. The company is actively pursuing AI opportunities across 100+ clients, helping them unlock value through operational efficiencies, time-to-market, and transformative business models through AI innovation. The pipeline for Microsoft Fabric stood at USD45mn. 10) 94.8% of the workforce and 80% of managers are AI-trained. The company also rolled out WIPE coding training, with 78% of the employees successfully completing it. 11) In SITL, Sonata continues to execute its three-pillar strategy: i) driving growth in Microsoft SMC (small, medium, corporate) accounts, ii) expanding AI-led partnerships with other ISVs such as Oracle, IBM, OpenText, etc, and iii) securing large system integration deals. 12) Quant Systems’ founder, Srini Veeravelli, decided to pursue opportunities outside of Sonata. The company has hired a new sales leader for Quant Systems to drive the next phase of growth. 13) The mgmt has stated that it intends to adopt a quarterly interim dividend policy starting this year. 14) Gross cash stood at Rs3.23bn, while net debt stood at Rs2.8bn.

For More  Emkay Global Financial Services Ltd Disclaimer http://www.emkayglobal.com/Uploads/disclaimer.pdf & SEBI Registration number is INH000000354