Sell Tata Elxsi Ltd for the Target Rs 2,970 by Motilal Oswal Financial Services Ltd
Margins to recover gradually Growth momentum improves, but Europe remains a key constraint
* Tata Elxsi (TELX) reported revenue of USD110m in 2QFY27, up 2.3% QoQ in CC terms, above our estimate of 1.7% QoQ CC. Growth was led by HLS /Media and Communication/Transportation, up 3.5%/3.4%/2.0% QoQ CC, whereas Others declined 10.2% QoQ CC. EBIT margin was 19.7% (up 70bp QoQ), above our estimate of 19.2%. Adj. PAT declined 0.2% QoQ and rose 10% YoY to INR1,703m (below our est. of INR1,862m).
* For 1HFY27, revenue/EBIT/adj. PAT grew 14.7%/20.8%/13.9% YoY in INR terms. We expect revenue/EBIT/adj. PAT to grow 11.6%/17.8%/14.2% YoY in 2HFY27. We value TELX at 20x FY28E EPS, resulting in a revised TP of INR2,970. We reiterate our Sell rating.
Our view: 2H revenue growth to be better than 1H
* Revenue grew 2.3% QoQ CC in 2QFY27, with growth across all three major verticals (~98% of revenue). The 2HFY27 growth outlook is expected to be better than 1HFY27 on a YoY basis. However, a sustained acceleration will depend on the conversion of deal wins into revenue, as new engagements typically take 2-3 quarters to ramp up. Accordingly, a larger contribution from recently closed deals is expected to be reflected in FY28, where we build in 8.2% YoY CC growth.
* European automotive demand is likely to remain a key growth constraint: Demand across Europe remains subdued, with automotive engineering spending and deal closures affected by cautious customer spending and delayed decision-making. The US and India are expected to remain relatively supportive, while growth across other verticals and geographies should partly offset continued weakness in Europe.
* EBITDA margin expanded by 70bp QoQ to 21.9% in 2QFY27. However, the benefit from cross-currency movements was estimated at 60-70bp, suggesting limited underlying sequential expansion. Company-wide wage hikes in 2Q were largely mitigated by reversal in one-offs, while continued investments in capabilities and delivery are expected to constrain nearterm
* Deal pipeline provides visibility, but conversion and ramp-up remain key monitorable: Multi-year engagements and a pipeline of opportunities across existing and emerging verticals provide revenue visibility. Aerospace and defense opportunities are progressing, although their near-term revenue contribution is likely to remain modest.
* Demand remains selective, with growth dependent on execution across verticals rather than a broad-based spending recovery: Healthcare is expected to improve in 2HFY27, while Media & Communications continues to benefit from project ramp-ups. We expect growth to remain uneven across verticals, with the strength of project ramp-ups and a recovery in Transportation determining the extent of any acceleration.
Valuations and changes to our estimates
* We lowered our FY27/FY28 EPS estimates by ~3%/~1%, reflecting a gradual margin recovery amid continued investments and an uneven demand environment, particularly continued softness in European automotive. We believe meaningful margin expansion is likely to depend on revenue growth, utilization gains and employee-pyramid correction.
* In addition, revenue conversion remains a key monitorable, as new engagements typically take 2-3 quarters to ramp up, limiting the near-term contribution from recently closed deals. We continue to model USD revenue CAGR of ~6.3% over FY26-28E. We value TELX at 20x FY28E EPS, resulting in a revised TP of INR2,970, and reiterate our Sell rating
Key highlights from the management commentary
* Global environment remains uncertain, but client priorities around innovation, digital engineering, AI and product modernization offer steady opportunities.
* European OEM issues are systemic (cost base, electrification), so Chinese vehicle import curbs are unlikely to change near-term spending.
* Demand is broad-based across verticals, with Europe auto being the only soft spot.
* Management expects H2 to be better than H1.
* Enterprise AI budgets continue, but are now more ROI-focused after early overspend, a slight qualitative improvement.
* Multi-year deal from a leading auto OEM for next-gen cloud-based telematics and connected vehicle ecosystem, only just started.
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