Everonn Systems India – BUY (Target Price Rs558, Upside 40.0%)

India – one of the largest education markets

A large student base (413mn+), low literacy levels, inadequate public education infrastructure, high drop-out rates, low gross enrollment ratio and increasing per capita income makes India one of the largest markets for educational services and infrastructure. Government spending on education is estimated at US$30bn+ pa. India’s private education market is estimated at US$40bn by E&Y. Education spend is expected to increase 12x per household between 1995-2025E with rising per capita income.

Everonn’s revenue and profit to grow at 60%+pa over FY09-12E

Everonn’s presence in the education sector is diversified across various businesses viz ICT for Government schools, virtual classrooms for private schools (iSchool) and colleges, retail learning centers for individuals and corporate training, online learning portal (Classontheweb.com), engineering test preparation (Toppers), educational material supply (Edures) and infrastructure consulting. We expect Everonn’s consolidated revenues to witness a robust 63% CAGR over FY09-12E driven by strong growth in college learning centers, iSchools and subsidiary (Edures and Toppers) revenues. Though increasing share of subsidiary revenues and decline in ICT profitability would act as margin headwinds, consolidate OPM is expected to be sustained near 35%, cushioned by material margin expansion in other businesses. With stable margin, company’s earnings are estimated to grow in-line with revenues.

OCF to breakeven in FY10; leverage to remain comfortable

We expect Everonn to attain operating cash flow (OCF) breakeven in FY10 and generate significant positive cash flows from FY11. OCF is likely to reach 80% of PAT in FY12. Improvement in cash flow would be aided by substantial increase in cash profits and decline in working capital cycle. We have factored improvement in receivable days over FY09-12 on account of declining share of ICT revenues. Balance sheet leverage would continue to be comfortable with net debt/equity below 0.5x despite majority capex funding via debt in FY10 and FY11. Further, interest cover is expected to remain healthy at 7-8x during FY10-12.

Valuation attractive at 6.4x FY12 P/E; Recommend BUY  

We believe that current valuation at 6.4x FY12 P/E is attractive as Everonn, a proxy play on India’s fast growing education spending, is expected to deliver robust earnings growth over the next five years. We recommend BUY on Everonn with a 1-year price target of Rs558 (9x FY12E EPS). However, company would continue to trade at significant discount to Educomp which is a more established and diversified player.