IGI Logo

ERD services—increasing caution on automotive demand

Indian ESPs’ revenue growth moderated in 1QFY25 and is lower than our estimate. More signs of weakening demand emerged in the automotive segment. EBIT margins improved marginally at KPIT and TELX, but declined across others sequentially. Cyient (DET) lowered its FY2025E revenue growth outlook, whereas LTTS and KPIT retained their guidance. We maintain SELL on LTTS, KPIT, TELX and TTL on rich valuations, baking in unrealistic longterm growth expectations.

Moderated revenue growth and lower-than-expected revenue growth in 1QFY25

Indian ERD service providers reported decelerating growth trends in the June 2024 quarter. Revenues were lower than our estimates across most companies, while TELX was marginally better. KPIT continued to grow at a robust rate (4.7% qoq), followed by TELX (2.4% qoq). TTL (services), LTTS, HCLT (ERD) and Cyient (DET) reported revenue declines of 1.3-5.0% qoq. EBIT margins improved 60 bps qoq at KPIT and TELX, but declined 30-260 bps qoq at TTL, LTTS and Cyient (DET).

FY2025E outlook cut at Cyient (DET), retained at LTTS and KPIT

Cyient (DET) lowered its FY2025E revenue growth outlook to flat yoy (high single digits earlier). While the near-term growth is likely to be strong, we believe the ask rate of 3.2% CQGR, without a material improvement in demand, remains aggressive. A similar case is LTTS, which retained its revenue growth guidance of 8-10%, implying ~4-5% CQGR over 2QFY25-4QFY25—a tough ask. KPIT also retained its FY2025E outlook of 18-22% growth, achievable assuming limited impact from deterioration in the automotive segment. More on this below.

Increasing caution in automotive R&D

The transportation vertical’s revenue growth remained strong across LTTS, TELX and KPIT in 1QFY25 (Exhibit 5). Growth was concentrated, driven by the ramp-up of large deals across companies–Forvia at LTTS, JLR and others at TELX and Japanese OEM engagements for KPIT. Automotive R&D spends were expected to remain at elevated levels in CY2024, as OEMs initially planned to continue their aggressive CASE investments. However, this now appears to be slowing down. Few peers highlighted an abrupt and sharp weakening in demand in the industry, especially in Europe, due to (1) slower-than-anticipated adoption of EVs and (2) rising cost pressures from increasing competition. For instance, Mercedes Benz’s R&D spends declined 7% yoy in 1HCY24.

Remain cautious on stretched valuations, amid signs of demand deterioration

We lowered our FY2025-27E earnings estimates across most companies after the 1QFY25 disappointment. Currently, we are not baking in much impact in the automotive segment and could present a further downside in the case of a sharper pullback in some R&D spends by auto OEMs. Other segments such as telecom and hi-tech remain sluggish, which could impact overall revenue growth at LTTS, Cyient (DET) and TELX. We remain cautious about stretched valuations at KPIT, TELX, TTL and LTTS (SELLs). Prefer Cyient (BUY) on reasonable valuations.

US growth remains sluggish; healthy growth momentum in Europe (ex-Cyient)

Revenue growth in the US has been tepid over the past five quarters (Exhibit 6). Revenues declined yoy at TELX and LTTS, whereas Cyient (DET) and KPIT reported modest growth (Exhibit 4). Automotive vertical-focused companies such as TELX and KPIT have limited presence in the market due to constraints on the addressable TAM and unfavorable terms of engagement.

Sharp yoy margin decline across companies (ex-KPIT)

EBIT margins declined 60-260 bps yoy across TELX, TTL, LTTS and Cyient (DET) (Exhibit 11). Moderating revenue growth and the need to invest in capabilities to expand the range of service offerings to clients have partly resulted in lower profitability. KPIT, on the other hand, continued to benefit from demand tailwinds and pricing benefits, resulting in a 130 bps margin improvement to 17.3%, despite the additional impact of ESOP charges (70 bps).

LTTS deferred its wage hikes by a quarter, effective October 2024, while KPIT announced increments in line with its regular appraisal cycle (starting July 2024), with average wage hikes in high single digits. TELX’s junior employees’ compensation would be revised from 2QFY25 and that of senior employees from 3QFY25; the average increase would be in the 5-6% range.

Headcount declines sequentially across most companies

Employee headcount declined qoq across Cyient (DET), LTTS, TELX and TTL (Exhibit 10). Headcount growth has decelerated cumulatively for Indian pure-play ERD services companies. These companies have focused on better resource utilization and hiring trainees to optimize cost structures over the past year.

Other highlights

* Bookings. Deal win trends were tepid during the quarter. Order intake declined 5% yoy to US$187 mn at Cyient (DET). At KPIT, deal TCV was up 6% yoy at US$202 mn and down 21% yoy on ttm basis.

* Attrition. LTM attrition was largely stable at LTTS and TELX sequentially at 14.8% and 12.3%, respectively. KPIT’s employee churn remains among the best in the industry at high single digits. Cyient (DET) and TTL reported 110 bps (16%) and 80 bps (13.7%) lower attrition qoq, respectively

Above views are of the author and not of the website kindly read disclaimer