Cyient Ltd. (Q1 FY15)

• Organic dollar revenue growth beats expectation; company expects growth momentum to continue 

• Sharp decline in operating margin was a negative surprise; FY15 margin likely to be significantly lower yoy

• PAT growth aided by higher other income and lower tax rate 

• Downgrade rating to Accumulate; reduce target price to Rs373

Organic dollar revenue growth beats expectation

Cyient’s organic dollar revenue growth came ahead of our expectation at 4.2% qoq. Adding US$3.6mn revenues of Softential, an acquisition made by the company in the previous quarter, revenue growth was higher at 7.8% qoq. Organic growth during the quarter was driven by both business segments of Engineering (up 4.6% qoq, comprising of erstwhile Aero and Hi-tech verticals) and DNO (up 3.5% qoq, comprising of erstwhile Utilities, Telecom and DTA verticals). Within DNO business segment, DTA vertical registered a robust growth of 9% qoq. Regionally, growth was driven by Americas (4.5% qoq excluding Softential) and APAC (12.3% qoq). Strong growth in Americas was on account of ramp up in key clients in Semiconductor, Aerospace, Energy, Communications and Utilities industries. Growth in APAC was driven by Energy and Communication industries. There was a significant onsite revenue shift of 500bps in DNO business segment which is largely attributable to addition of Softential revenues. Over the past three quarters, Cyient has delivered an impressive organic CQGR of 4.6%. Management expects growth momentum to continue in coming quarters based on current order book and pipeline.

Sharp decline in operating margin was a negative surprise

Against our expectation of 270bps qoq contraction, Cyient’s operating margin declined by steeper 400bps. The key operating headwinds being salary increases (300 bps) and currency appreciation (110 bps). Additionally, integration of lower margin Softential revenues and initial investments (onsite shift + higher subcontracting) on a large utilities project in North America also impacted margin during the quarter. At 14%, operating margin was at a multi-quarter low. While utilization in Engg business segment improved a bit, it fell sharply in DNO segment due to aforesaid reasons. Though utilization and offshoring remain key levers for the company to recoup margin fall, we believe that Cyient will post significantly lower operating margin in FY15 (16-16.5%) v/s FY14 (18.6%) unless growth remains robust (4-6% qoq) through the year. 

PAT growth aided by higher other income and lower tax rate 

Q1 FY15 net profit at Rs685mn was higher than expected. The bottomline outperformance was driven by higher other income (lower losses on forex hedges and better translation gains) and lower tax rate at 23% (continued deployment of new business into SEZs and one-off benefits).  For the full year, company expects tax rate to be 2% lower than FY14. Including addition from Softential, net employee add stood at 445, a growth of 3.7% on previous quarter base. 

Downgrade rating to Accumulate; reduce target price to Rs373

In spite of marginal revenue beat, overall operating performance of Cyient was below expectation. Being less optimistic than the management on medium-term margin recovery, we have lowered our operating margin assumptions for FY15/16. But, our earnings estimates have not see any material revision on account of higher other income and lower tax rate assumptions. However, weakening of margin profile remains our key worry now and we build it by marginally lowering target valuation multiple. Consequently, we reduce our 9-12 month target on Cyient to Rs373 and downgrade rating to Accumulate from Buy.