INITIATING COVERAGE 4 SEP 2013 Infotech...

INITIATING COVERAGE 4 SEP 2013

Infotech Enterprises BUY

Capex moderation to boost FCF generation Infotech Enterprises, a mid-sized IT vendor with specialisation in engineering design has been showing improvement on a host of operating metrics, which aids scope for a re-rating. These include broadening geographic mix of business, expanding into growth verticals, steep improvement in free cash flow generation and stepping up dividend payout ratio. However, the company’s FY13 US$ revenue growth at 6.5% YoY remained muted owing to slowdown in the select top clients. We expect a turnaround in growth trajectory from 2HFY14 onwards driven by strong deal pipeline as well as expected ramp ups from select new clients.

Engineering (~64% of revenues) services is likely to show good traction driven by growth in Aerospace and Railways vertical. Utilities Telecom &Data Analytics (~35% of revenues) is likely to show traction led by growth in APAC region (especially Australia). Strong hiring did not translate in revenue growth in FY13 owing to slowdown in select large clients. Hence, we see a scope for improvement in utilisation rates, which could act as a margin lever.

Net cash on balance sheet Rs 6.09bn (Rs 54.5/sh), dividend payout ratio of 22% and improving DSO are other key positives. Moderation in capex spends has aided free cash flow generation( EBIDTA/Capex ratio at 3.3 x, 3.7x and 4.7x for FY12, FY13, FY14E). At P/E of 7.6x on FY14E and EV/EBIDTA of 3.3x, the stock looks attractive. We value stock at 9x on FY15E EPS which yields TP of Rs236/sh. Initiate with BUY.

Engineering Design : Infotech Enterprises is strongly entrenched in engineering design outsourcing value chain providing services across the product life cycle value chain. Major clients include Pratt and Whitney, Hamilton Sundstrand, Bombardier, Alstom, Caterpillar. Niche competency and relatively under penetrated nature of the service line enables growth. Ramp up of the new clients in aerospace and mining of existing clients in Railways is likely to aid growth in FY14.

UT&DA : The company provides network solutions and GIS services to Utilities, Telecom and Digital Map providers. Major clients in the segment include Tom Tom, Airtel and AT&T. Strong growth opportunities driven by demand for Broadband and Backhaul (FTTx) services is driving growth in this segment.

Valuations and view : We expect 3.5/8.1% US$ revenue growth in FY14/FY15E driven by higher traction in UT&DA services as well as recovery in engineering services. We expect EBIDTA margins at 19.4/18.3% for FY14/FY15E. We value Infotech at 9x on FY15E EPS, which gives a TP of Rs 236/sh. Initiate with BUY.

FINANCIAL SUMMARY (Rs mn) FY12 FY13 FY14E FY15E Net Sales 15,531 18,730 21,936 23,650 EBITDA 2,705 3,417 4,246 4,319 PAT 1,614 2,312 2,721 2,932 Diluted EPS (Rs) 14.49 20.69 24.35 26.24 P/E (x) 12.7 8.9 7.6 7.1 EV / EBITDA (x) 5.9 4.4 3.3 2.8 RoE (%) 14.8% 18.7% 19.1% 17.9% Source: Company, HDFC sec Inst Research

INDUSTRY IT SERVICES

CMP (as on 3 Sep 2013) Rs 185

Target Price Rs 236 Nifty 5,341

Sensex 18,235

KEY STOCK DATA

Bloomberg/Reuters INFTC IN/INFTC.BO

No. of Shares (mn) 112

MCap (Rs bn) / ($ mn) 21/ 305

6m avg traded value (Rs mn) 18

STOCK PERFORMANCE (%)

52 Week high / low Rs 211 / 157

3M 6M 12M

Absolute (%) 10.8 8.8 2.9

Relative (%) 17.5 12.2 (1.6)

SHAREHOLDING PATTERN (%)

Promoters 22.35

FIs & Local MFs 6.20

FIIs 30.44

Public & Others 41.01 Source : BSE

Madhu Babu [email protected] +91-22-6171-7316

HDFC securities Institutional Research is also available on Bloomberg HSLB <GO> & Thomson Reuters

INFOTECH ENTERPRISES : INITIATING COVERAGE

Business profile Infotech Enterprises provides engineering solutions,

including product development and life-cycle support, network and content engineering to major global organisations. Infotech has 10,817 associates across 38 global locations helping serve clients spanning multiple industries such as Aerospace, Consumer,

Energy, Medical, Oil and Gas, Mining, Heavy Equipment, HiTech, Transportation, Telecom and Utilities. The company has a total base of 299 clients which include 22 'Fortune 500' and 27 'Global 500' blue chip organisations.

Business profile of the company

Source : Company ,HDFC sec Inst Research

Vertical mix of Revenues (%)

Engineering 64.0 a) Aerospace 36.0 b)HTH 28.0 UT and D&A 34.9 a) Utilities &Telecom 23.5 b)D&A 11.4 Others 1.1

Geographical mix (%)

North America 56.8 Europe 26.8 Rest of world 16.4

Revenues

Client Concentration (%)

Top 5 clients 36.6 Top 10 Client 49.3 Major clients

• Pratt &Whitney • Tom Tom • Hamilton Sundstrand • Bombardier • Alstom

Headcount Total Employees 10,817

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Engineering Design Services Accounts for 64% of revenues, delivered 17.6% revenue growth CAGR (FY08-FY13)

Within Engineering design, Infotech predominantly focus on the Aerospace, Railways, Hitech and Heavy Engineering verticals. Aerospace and HTH accounted for 36% and 28% of the total revenues respectively as

on 1QFY14. Infotech’s services are present across the engineering service value chain. This includes conceptual design, prototyping, manufacturing and after sales support. The offerings include drawing, engineering analysis, (stress analysis, thermal analysis, computational fluid dynamics), design of sub-systems or components that make up the end products.

Engineering services value chain

Design & Engineering 3D CAD and detailing Engineering analysis (FEA/CFD) PDM implementation Technical publications Manufacturing engineering Test Rig development Instrumentation & controls

Manufacturing Support Vendor management Sourcing of subassemblies Tooling (cutting tools, jigs & fixtures, machine tools) Sourcing of forgings & castings (Ferrous & non-ferrous) Design & manufacturing of test rigs for Aerospace application Sourcing of Semi finished & finished components (Ferrous & non-ferrous) Rapid phototyping Precision machining

Source : Company, HDFC sec Inst Research

Engineering Design

Concept

Modeling

Simulation

DOE Studies

Prototyping

Prototypes

Validation

Customization

Manufacturing

Production, Planning, Control Material

Management, Inquiry 2

Customer Service

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Infotech’s services to clients include work like 2D drafting, 3D modeling, digital mock-ups, conceptual design, design validation, manufacturing coordination, and quality consulting. The company has a long standing relationship with major customers in this service line. Considering the long sales cycle and high entry barriers, Infotech Enterprises enjoys a unique position in the industry. Some of the marquee relationships include :

Strong client relationships Client Vertical Years of relationship

Pratt and Whitney Aerospace 13 years Hamilton Sundstrand Aerospace 9 years Boeing Aerospace 8 years Bombardier Railways 10 years Invensys Railways 7 years Caterpillar Heavy Engineering 4 years Source : Company, HDFC sec Inst Research

Huge scope for scalability in Engineering Design Services Opportunity in Engineering design by CY20


The market for engineering design services from India is expected to reach US$ 37-45bn by CY20, with an expected CAGR of 18% thereby outpacing the growth in IT services. As on FY13, Engineering design services exports from India stood at ~US$11bn. Automotive, Consumer Electronics and Telecom are the major segments driving spending in the service line.

Among the verticals, the market opportunity appears to be the highest for HiTech/Telecom (US$ 17bn by CY20) and Automotive (US$ 8bn by CY20). The Aerospace vertical in which Infotech enjoys a strong competence is likely to be a US$ 3bn opportunity for the Indian players by CY20. The other competing countries in the engineering outsourcing are Canada, China, Mexico, and Eastern Europe. This huge market size provides a tremendous opportunity for the Indian offshoring players and the sheer size could aid multiple players to co-exist.

Strong competency in the Aerospace value chain Infotech Enterprises specialises in the aerospace

vertical (accounts for 36% of the total revenues) catering to aero structures, aero engines, Interiors and seating, avionics, mechanical systems. The major clients include the United Technologies Corporation (UTC) group companies, which comprise Pratt and Whitney (aero engine manufacturer), Hamilton Sundstrand (aerospace products) and Sikorsky (Helicopters). Pratt and Whitney is the largest client for Infotech Enterprises (~15% of total revenues). Apart from the UTC group, the company offers engineering services to other airline manufactures like Boeing and Airbus, Tier 1 suppliers to aircraft manufactures like GKN aerospace, Smith Aerospace. Infotech has expanded its gamut of offerings to the entire aerospace value chain, which has enabled it to broader its client base, and to tap new scalable accounts.

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The airplane design cycle is typically a long process (around 6 years) and predominantly involves a variety of suppliers who specialise in their particular components. The commercial airline industry mainly follows a duopoly market structure with two dominant players viz. Boeing and Airbus (Infotech currently works with both the players). The other major offshore IT players with a strong presence in the Aerospace vertical are TCS, HCL (in Avionics) and Wipro (in Avionics).

The key component to power airlines is aero engines, which are globally manufactured by the three major players : Pratt and Whitney, GE and Rolls Royce. However, with its exclusivity agreement with Pratt Whitney, Infotech Enterprises at present cannot directly enter into a contract with GE and Rolls Royce.

Aircraft development also includes a lot of subcontractors and component outsourcing is an increasing trend in the industry. The Boeing’s Dreamliner project had 900 subcontractors and Boeing Indicated that 70% of the Dreamliner work was outsourced. Infotech Enterprises currently works with a variety of Tier 1 suppliers in the aerospace industry like GKN Aerospace, Smith Aerospace.

The aerospace vertical(contributes to 56% of engineering revenues) delivered a muted growth of 5% YoY in FY13 owing to internal restructuring issues within top accounts. However, we expect the aerospace vertical revenues to recover in FY14 driven by traction in new accounts. Infotech indicated moving up the value chain in aerospace and is now working on risk-reward and outcome based pricing engagements.

Railways: Infotech enjoys strong expertise in Rolling stock and Signaling services The Railways (part of the HTH vertical, accounts for

~11% of the total revenues) is another arena of expertise for Infotech Enterprises in the Engineering division. The major clients in the vertical are Bombardier, Alstom, Invensys for which the company provides services like design (car body design, bogies, machine room) and analysis (vehicle dynamics, fatigue, frequency response, lighting systems).The service provided include drafting, detailing, modeling and analysis of designs that are used to manufacture trains. The other major clients in railways include Network Rail, Madrid Metro, Singapore Downtown Line, Melbourne & Auckland Metro, Turkish Rail, Taiwan Metro.

Railways vertical has seen slowdown in FY13 owing to a weakness at a large account due to Olympics, which has led to a temporary suspension of select projects. As per our interaction with the management, the Railways vertical is delivering robust traction over the past two quarters and is likely to grow at a healthy rate in FY14.

Acquisitions aid expansion into HiTech and Heavy engineering verticals Infotech Enterprises strengthened the Heavy

Engineering and HiTech verticals over the past five years, which was predominately through acquisitions. The marquee clients in the vertical include Caterpillar, Phillips, John Derre, Komatsu. The segment has been showing volatile outlook over the past five quarters owing to slowdown in few clients (Texas Instruments and Caterpillar).

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Acquisitions done by Infotech Enterprises from FY09-FY13 Company Area of Expertise Amount spend Number of

employees Year of acquisition Vertical Strengthened

Time To Market (TTM) Semiconductor ~US$ 8mn 130 Sep 2008 HiTech

Daxcon Off highway equipment and Heavy Engineering ~US$8mn 150 Jan 2010 Heavy Engineering

Wellsco Telecom ~US$5mn 180 August 2010 Telecom Source : Company, HDFC sec Inst Research Niche competency enables better client stickiness The major players in Indian engineering design services

outsourcing market are captives of the MNCs, large IT vendors like TCS, Wipro, OEM vendors offering outsourced design services and niche players like

Infotech Enterprises. We believe that the niche players definitely stand to gain in the engineering services business due to their dedicated focus.

Category Major companies Nature of offerings

Captive Units Bechtel, Flour Daniel, Kvaerner, Ford, Daimler Chrysler, General Motors, Caterpillar, Texas Instruments, Cadence

Predominantly automobile companies and semiconductor players who offer services to the parent company

IT Vendors with an Engineering Services Practice HCL Technologies, Infosys, TCS and Wipro Leveraging the offshore model

OEM Vendors L&T, Thermax, Mahindra, Hero Global Design Have sizeable design departments that offer services on an outsourced basis

Specialist Engineering Services Vendors Nielsoft, Sierra Atlantic, Quest, Infotech Enterprises

Focus on engineering design services and developing core competence in the same


Growth in Engineering service line ENGINEERING DESIGN SERVICES US$ mn FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E Engineering 34.9 44.6 73.4 102.6 126.5 130.5 180.1 224.3 230.7 230.7 247.8 Growth(%) 28.0% 64.4% 39.7% 23.3% 3.1% 38.0% 24.5% 2.9% 0.0% 7.4% Proportion of Total Revenues 60.3% 54.2% 61.2% 61.7% 65.3% 64.9% 69.1% 69.3% 66.8% 64.6% 64.2% Source : Company, HDFC sec Inst Research

Overall , the Engineering services vertical delivered a 17.6% CAGR(FY08-FY13) driven by scaling up of large client relationships , new client additions as well as acquisitions. However, FY13 has shown weakness owing to softness in select large clients. We expect growth in the vertical is pick

up and accelerate from 2HFY14 and model 4% CAGR(FY13-FY15E). EBIDTA margins for the Engineering vertical stood at 18.2% for FY13 down 60bps YoY due to drop in utilization rates.

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Utilities, Telecom &Data Transformation Analytics (UT&DA) Accounts for 34% of total revenues, delivered 12.4% CAGR (FY08-FY13)

Infotech is among the leading offshore provider for Geospatial Information Systems (GIS) services and caters to industries like Utilities, Telecom service providers and Data Transformation and Analytics (D&A). The company has over 4,700 employees catering to the UT&DA vertical as on 1QFY14. The services include data management services, photogrammetric and image processing, geospatial technology solutions.

The largest client among the GIS services is Tele-Atlas (which was acquired by Tom Tom), a Netherlands-based company, which provides Digital Maps catering to navigation systems. Apart from Tele-Atlas, the other major large clients in the UT&DA segment are KPN, Swisscom, BT, Airtel, Powercor Australia, AT&T, Ausgrid, Rio Tinto. The engagements in the UT&DA service line are predominantly project-based, which are executable over the period of 18-24 months.

Tele-Atlas, a key client in Data segment

There is an increased demand for Digital Map databases especially in the North American and European market due to the emergence of new business models like car navigation devices. Infotech has a long-standing relationship with Tele-Atlas, which is a leading provider of digital maps based out in

Netherlands. Tele-Atlas has been acquired by TomTom in 2008 and now is a subsidiary of Tom Tom.

Tele-Atlas has been the client of InfoTech Enterprises since 1994 and is currently among the top 5 clients of the company. Infotech provides crucial functions of converting the Input data into digital maps with its experienced digital data cartographers located in the Noida and Hyderabad centers.

Demand for Network design services from Utilities & telecom service providers

GIS plays an important role in network planning, design and disaster recovery for telecom and utility providers and Infotech is poised to benefit from its expertise in these arenas. Infotech has the scale and capability to execute large projects and has been associated with the largest telecom service providers like BT, KPN Telecom, Airtel. The company has diversified its geographic presence in the GIS business and is witnessing a rapid growth in APAC aided by new client additions.

UT&DA vertical delivered a healthy growth of 12.4% CAGR (FY08-FY13) driven by strong traction in the existing as well as new clients and expansion into emerging markets. We expect UT&DA vertical to deliver 10% CAGR (FY13-FY15E) driven by strong traction across the major sub-segments in the vertical. The segment had an EBIDTA margin of 17.4% for FY13 up 240bps on a YoY basis.

UT&DA Revenues US$ mn FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E UT&DA 23.0 37.7 46.6 63.7 67.2 70.5 80.7 99.2 114.2 125.7 138.3 Growth(%) 64.2% 23.7% 36.5% 5.6% 4.9% 14.5% 22.9% 15.1% 10.1% 10.0% Proportion of Total Revenues 39.7% 45.8% 38.8% 38.3% 34.7% 35.1% 31.0% 30.7% 33.1% 35.2% 35.8% Source : Company, HDFC sec Inst Research

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Key Operating Metrics UT&DA service line has been generating robust

traction over the past couple of quarters driven by growth opportunities in Utilities vertical as well as higher traction in emerging markets. Infotech has been witnessing a strong growth in APAC (especially in Australia).

Engineering has been witnessing a muted growth over the last six quarters due to volatile growth in Railways vertical and weakness in the Heavy engineering and Hitech verticals. However, we believe that the revenues from the service line have bottomed and expect turnaround from 2HFY14 onwards.

REVENUE BY NATURE OF SERVICES

(%) Q1 FY11

Q2 FY11

Q3 FY11

Q4 FY11

Q1 FY12

Q2 FY12

Q3 FY12

Q4 FY12

Q1 FY13

Q2 FY13

3Q FY13

4Q FY13

1Q FY14

UT and D&A 29.5 30.5 32.5 30.9 30.6 30.8 30.6 30.6 31.7 32.5 33.9 34.3 34.9 Engineering 70.5 69.5 67.5 69.2 69.4 69.2 69.4 69.4 68.5 67.7 65.0 64.6 64.0 Others -0.06 -0.01 -0.10 -0.08 0.0 0.0 0.0 0.0 -0.1 -0.2 1.10 1.1 1.1 Total 100.0 100.0 100.0 100.00 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Source : Company, HDFC sec Inst Research

GEOGRAPHICAL REVENUE MIX

Q1 FY11

Q2 FY11

Q3 FY11

Q4 FY11

Q1 FY12

Q2 FY12

Q3 FY12

Q4 FY12

Q1 FY13

Q2 FY13

3Q FY13

4Q FY13

1Q FY14

North America 52.2 55.0 55.8 57.7 58 56.7 54.8 59.7 62.5 61.1 60.7 56.3 56.8 Europe 38.4 37.5 36.0 33.9 33.7 33.6 34.8 28.5 25.7 26.4 25.3 27.3 26.8 APAC 9.4 7.4 8.2 8.5 8.3 9.7 10.4 11.8 11.8 12.5 14.0 16.4 16.4 Source : Company, HDFC sec Inst Research

CLIENT CONCENTRATION

Client concentration Q1 FY12

Q2 FY12

Q3 FY12

Q4 FY12

Q1 FY13

Q2 FY13

3Q FY13

4Q FY13

1Q FY14

Top 5 37.5 36.6 36.4 38.3 38.6 36.3 36.8 35.1 36.6 Top 10 55.9 53.7 52.3 55.2 55.2 51.8 51.8 48.1 49.3 Source : Company, HDFC sec Inst Research

Despite having a total client base of 299 accounts, Infotech has a high client concentration with top 10 accounts contributing to 49% of total revenues. Infotech Enterprises client concentration is similar to other midcap peers (Mindtree and Hexaware derive

46%, 53% of revenues from top 10 clients respectively). Some of the top 10 clients of Infotech Enterprises include Pratt and Whitney, Hamilton Sundstrand, Tom Tom, Bombardier, Alstom.

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HEADCOUNT

Q1FY12 Q2FY12 Q3FY12 Q4FY12 Q1FY13 Q2FY13 3QFY13 4QFY13 1QFY14 UT&C 3,693 3,952 4,131 4,185 4,507 4,595 4,758 4,721 4,774 Engineering 4,525 4,510 4,415 4,508 4,619 4,810 4,661 5,076 5,268 IT services 57 67 73 78 87 100 112 118 120 Support 600 584 578 563 585 588 603 602 653 Total Employees 8,875 9,113 9,197 9,334 9,798 10,093 10,134 10,517 10,815 Net additions 238 84 137 464 295 41 383 298 Source : Company, HDFC sec Inst Research Infotech Enterprises has lower revenue per employee

among mid-sized IT peers due to its presence in GIS business, which has lower realizations per employee. We have calculated the revenue per reported employee base across mid-sized IT vendors (FY14E USD revenues divided by total reported headcount as on 1QFY14). This ratio also varies across companies as each firm operates at a different effort mix (onsite:

offshore ratio) and utilisation rates. Infotech has lower revenue per employee owing to GIS business as well as its lower utilisation rates in ENGG services (66% as on 1QFY14). However, it should be noted that though UT&DA business have a lower revenue per employee, the division had at EBIDTA margin of 17.5% for FY13.This is on account of lower cost structure in the division.

REVENUE (FY14E) PER REPORTED EMPLOYEE BASE COMPARISON FOR MIDSIZED IT VENDORS

Revenues

(FY14E) Headcount Revenue per employee (US$)

Revenues delivered from onsite (1QFY14)

FY13 EBIDTA Margin (%)

Infotech 356 10,815 32,917 51.7% 18.2% Mindtree 496 12,239 40,526 38.7% 20.6% Hexaware 386 8,700 44,368 52.5% 20.9% NIIT Tech 407 8,207 49,592 63.0% 16.3% KPIT 459 8,456 54,281 54.1% 16.3% Source : Company, HDFC sec Inst Research

UTILISATION RATES(%)

Q1FY12 Q2FY12 Q3FY12 Q4FY12 Q1FY13 Q2FY13 3QFY13 4QFY13 1QFY14 UT&DA 86 70 88 82 84 85 83 80 83 Engineering 74 73 72 73 71 73 71 68 66 Source : Company, HDFC sec Inst Research

DAY SALES OUTSTANDING

Q1FY12 Q2FY12 Q3FY12 Q4FY12 Q1FY13 Q2FY13 3QFY13 4QFY13 1QFY14 DSO(Inc Unbilled) 90 92 104 99 99 101 98 95 95 Source : Company, HDFC sec Inst Research

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EARNINGS AND FINANCIAL OUTLOOK Revenues (US$ mn) FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E UT&DA 22.9 37.6 46.6 63.6 67.2 70.5 80.7 99.2 114.2 125.6 138.3 Growth(%) 64.2% 23.7% 36.5% 5.6% 4.9% 14.5% 22.9% 15.1% 10.1% 10.0%

Engineering 34.9 44.7 73.5 102.7 126.6 130.5 180.2 224.4 230.8 230.7 247.9 Growth(%) 28.0% 64.4% 39.7% 23.3% 3.1% 38.0% 24.5% 2.9% 0.0% 7.4%

Total Revenues(US$ mn) 58 82 120 166 194 201 261 324 345 357 386 Growth(%) 42.4% 45.8% 38.5% 16.5% 3.7% 29.7% 24.1% 6.7% 3.5% 8.1%

Average Exchange rate 44.61 44.02 45.21 40.66 46.01 47.51 45.6 47.9 54.3 61.3 61.3 % Change -1.3% 2.7% -10.1% 13.2% 3.3% -4.0% 5.1% 13.2% 12.9% -0.1%

Total Revenues (Rs mn) 2,581 3,626 5,430 6,762 8,918 9,551 11,880 15,531 18,730 21,936 23,650 Growth (%) 40.5% 49.8% 24.5% 31.9% 7.1% 24.4% 30.7% 20.6% 17.1% 7.8%

EBIDTA 468 658 1,134 1,217 1,785 2,083 1,803 2,705 3,417 4,246 4,319 EBIDTA Margin(%) 18.1% 18.2% 20.9% 18.0% 20.0% 21.8% 15.2% 17.4% 18.2% 19.4% 18.3% Net Profit 274 504 836 855 925 1,708 1,395 1,614 2,312 2,721 2,932 NPM(%) 10.6% 13.9% 15.4% 12.6% 10.4% 17.9% 11.7% 10.4% 12.3% 12.4% 12.4% Source : Company, HDFC sec Inst Research

Revenue growth : Infotech delivered a muted US$ revenue growth of 6.7% in FY13 owing to weakness in engineering division. Company has seen weakness in few large accounts like Texas Instruments, Caterpillar which hurt growth. This is evident from lowered proportion of revenues from top 10 clients (49% as on 1QFY14 vs. 55% in 1QFY13). Infotech has guided that FY14 US$ revenue growth to be at par with FY13, which hints at ~6.7% US$ revenue growth in FY14. Considering the weak start in 1QFY14 (flat organic growth), Infotech would need to deliver a 4.4% CQGR over the remaining three quarters, to achieve it. This remains an uphill task and hence we model a lower growth of 3.5% US$ revenue growth for FY14E, which requires an asking rate of 2.6% CQGR.

EBIDTA margins : Infotech Enterprises has registered a steep fall in EBIDTA margins in FY11 owing to increased

lateral hiring, increased investment in sales and marketing, acquisition of companies with higher onsite presence (Daxcon and Wellso), as well as currency headwinds during FY11. As on FY13, Infotech Enterprises is operating at EBIDTA margins of ~18.2%, which is inline with midcap peerset. Scope for improvement in utilisation rates in Engineering segment as well as SG&A leverage could act as margin levers in the medium term.

Net cash on balance sheet : Improved free cash flow generation over the past two years helped Infotech Enterprises increase dividend payout ratio as well as strengthen its balance sheet. Net Cash on balance sheet stands at Rs6.09bn (Rs 54/share). This represents 30% of the Mcap of the company. Management has indicated scouting for acquisitions and has signed LOI’s with two companies.

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IMPROVING FREE CASH FLOW GENERATION

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E Cash flow from Operations 269 311 847 590 1,548 1,261 933 1,257 1,606 2,342 2,770 CFO/PAT 98.0% 61.7% 101.3% 69.0% 167.4% 73.8% 66.9% 77.9% 69.5% 86.1% 94.5%

Capex+ Acquisitions 274 340 706 1400 1283 718 946 804 924 900 900

FCF from Operations (5) (29) 141 (810) 266 543 (13) 453 682 1,442 1,870

FCF/PAT -1.9% -5.8% 16.9% -94.8% 28.7% 31.8% -0.9% 28.1% 29.5% 53.0% 63.8% Source : Company, HDFC sec Inst Research Infotech Enterprises had a weak free cash flow during

FY05-FY09 period owing to higher capital expenditure as well as working capital cycle. This has led to a significant strain on the balance sheet. During FY08, Infotech increased its equity capital by 15% through the issuance of preference share to General Atlantic and Carrier to raise ~Rs 3bn at a price of Rs 180/sh.

However, the company’s free cash flow generation has substantially improved over the past four years, which has led to a strong cash accretion on the balance sheet. Cash on balance sheet, which is currently at Rs6.1bn has grown at 13% CAGR (FY08-FY13).

Improving cash generation has also helped Infotech to raise its dividend payout ratio, which is currently at 22% for FY13 ( vs. 17%, 9.9%, 7.5% in FY12, FY11 and FY10 respectively).

Infotech indicated at pursuing acquisitions and has signed Letter of Intent with two companies. We believe that an acquisition could help company boost its ROE, which is currently at 18% and well below the industry average (Large cap as well as midcap).

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Quarterly Trends in the Results US$ revenue Growth Trajectory(QoQ)


EBIDTA Margins(%)


Quarterly revenues and EBIDTA margin metrics Infotech has shown a muted revenue growth

performance over the past six quarters owing to slowdown in the select large clients. Infotech Enterprises revenue trajectory has been disappointing as compared to other mid-sized IT vendors during this period. We believe that while traditionally IT service providers tend to benefit from the pent up demand in discretionary spending, Infotech would have a more steady business owing to its focus on engineering services. Management guided for pick up in revenue traction from 2HFY14.

Infotech has also shown a volatile performance on the EBIDTA margins front. The company has seen a steep drop in margins during the period of 1QFY11-1QFY12 owing to substantial wage hikes, increased hiring , strengthening INR vs US$ and acquisition of companies with higher onsite presence (Daxcon and Wellsco).

Infotech’s margins have been missing street expectations in FY13. This was on account of slowing growth trajectory coupled with aggressive hiring by the company during the period, which hurt the utilisation rates and hence impacted margins.

We see scope for improvement in utilization rates and benefits from currency tailwinds aiding EBIDTA margins from 2QFY14 onwards.

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16.0%

18.0%

20.0%

22.0%

24.0%

Q1F

Y10

Q2F

Y10

Q3F

Y10

Q4F

Y10

Q1F

Y11

Q2F

Y11

Q3F

Y11

Q4F

Y11

Q1F

Y12

Q2F

Y12

Q3F

Y12

Q4F

Y12

Q1F

Y13

Q2F

Y13

Q3F

Y13

Q4F

Y13

Q1F

Y14

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Valuations Infotech Enterprises has traded in a wide P/E band

based on growth and EBIDTA margin trajectory of the company. During FY06, FY07 the company has delivered a higher revenue growth (+30% USD revenue growth) as well as robust EBIDTA margins (+20% upwards). Hence, the company was trading at P/E multiples of 15-17x during that phase. However, the valuations have taken a steep hit during the Lehman crisis during which the company traded at low multiples of 4x forward earnings.

Owing to current muted growth as well as margin performance, the stock is currently trading at 7.1x on FY15E. We believe that any marginal improvement in growth trajectory could help substantial re-rating for the stock. Considering the niche competency, marquee client base and strong balance sheet, we value Infotech at 9x FY15E EPS which yields a TP of Rs236/sh. Initiate coverage with BUY.

One year forward PE chart of Infotech Enterprises

Source : Bloomberg, HDFC sec Inst Research

PEER VALUATIONS

CMP (Rs)

Mcap (Rs bn)

EPS P/E EV/EBIDTA ROE(%)

FY12 FY13 FY14E FY15E FY12 FY13 FY14E FY15E FY12 FY13 FY14E FY15E FY12 FY13 FY14E FY15E

Infotech Enterprises 185 20.4 14.5 20.8 24.3 26.2 12.7 8.9 7.6 7.1 5.9 4.4 3.2 2.7 14.8 18.7 19.1 17.9

Eclerx 860 25.7 53.0 57.0 80.3 85.7 16.4 15.2 10.8 10.1 11.8 8.8 6.8 6.1 56.2 44.0 48.2 40.7

Hexaware 131 38.5 8.9 10.9 12.6 13.2 14.7 12.0 10.4 9.8 13.1 8.5 6.9 6.6 26.9 29.5 29.5 27.3 NIIT Tech 285 17.3 33.2 35.5 41.9 45.8 8.6 8.0 6.8 6.2 5.5 4.3 3.6 3.2 23.7 21.3 21.4 20.2 Mindtree 1050 43.8 54.1 81.7 105.9 106.2 19.4 12.9 9.9 9.9 13.6 7.9 6.4 5.6 25.2 29.9 29.6 23.8 KPIT Cummins 132 25.5 8.1 10.6 14.5 15.8 16.3 12.5 9.1 8.4 12.0 6.8 5.5 4.9 22.1 22.5 24.2 21.5


0.00

5.00

10.00

15.00

20.00

25.00

Aug-

07De

c-07

Apr-

08Au

g-08

Dec-

08Ap

r-09

Aug-

09De

c-09

Apr-

10Au

g-10

Dec-

10Ap

r-11

Aug-

11De

c-11

Apr-

12Au

g-12

Dec-

12Ap

r-13

Aug-

13

Forward P/E Ratio 6 year Average P/E

Page | 13


INCOME STATEMENT (Rs mn) FY11 FY12 FY13 FY14E FY15E USD Revenue Growth 260.7 323.6 345.3 357.4 386.2 Growth (%) 24.1% 6.7% 3.5% 8.1% Net Sales 11,880 15,531 18,730 21,936 23,650 Growth (%) 30.7% 20.6% 17.1% 7.8% Cost of software Development 7,368 9,462 11,280 13,456 15,015 SG&A Expenses 2,709 3,364 4,033 4,235 4,316 EBIDTA Profits 1,803 2,705 3,417 4,246 4,319 EBIDTA Margin(%) 15.2% 17.4% 18.2% 19.4% 18.3% Depreciation 486 494 636 796 851 EBIT 1,317 2,211 2,781 3,449 3,468 EBIT Margin(%) 11.1% 14.2% 14.8% 15.7% 14.7% Other Income 295.5 168.0 397.3 422.1 520.0 Interest 15 14 12 28 28 PBT 1,597 2,365 3,166 3,844 3,960 Tax 270 835 966 1,254 1,188 PAT 1,327 1,530 2,200 2,589 2,772 Share of Profit from Associates 68 10 128 131 160 EO items (net of tax) 0 0 16 0 0 APAT 1,395 1,540 2,328 2,721 2,932 APAT Growth (%) 10.4% 51.1% 16.9% 7.8% EPS 12.64 14.49 20.69 24.35 26.24 EPS Growth (%) 14.7% 42.8% 17.7% 7.8%

Source: Company, HDFC sec Inst Research

BALANCE SHEET (Rs mn) FY11 FY12 FY13 FY14E FY15E SOURCES OF FUNDS Share Capital 556 557 558 558 558 Reserves 9,737 11,017 12,663 14,695 16,886 Total Shareholders Funds 10,293 11,574 13,221 15,253 17,444 Share application money - - 4 - - Long Term Debt 20 - - - - Short Term Debt 13 34 3 3 3 Total Debt 33 34 3 3 3 Deferred Taxes 11 33 45 50 55 Long Term Provs & Others 420 493 380 460 540 TOTAL SOURCES OF FUNDS 10,757 12,134 13,653 15,767 18,042 APPLICATION OF FUNDS Net Block 2,909 3,148 3,335 3,439 3,488 CWIP 13 108 219 219 219 Goodwill 471 209 26 26 26 Non Current Investments 578 244 373 373 373 LT Loans & Advances 685 798 951 1,151 1,401 Current Investments 334 222 610 610 610 Debtors 2,567 3,675 4,007 5,108 5,508 Cash & Equivalents 3,507 4,560 4,984 6,156 7,804 ST Loans & Advances, Others 786 1,072 1,593 1,993 2,493 Total Current Assets 7,194 9,529 11,194 13,867 16,414 Creditors 459 847 1,212 1,475 1,645 Other Current Liabilities & Provisions 637 1,054 1,234 1,834 2,234

Total Current Liabilities 1,096 1,901 2,445 3,308 3,879 Net Current Assets 6,099 7,628 8,749 10,559 12,535 TOTAL APPLICATION OF FUNDS 10,755 12,135 13,654 15,767 18,042


Page | 14


CASH FLOW (Rs mn) FY11 FY12 FY13 FY14E FY15E Reported PAT 1,162 1,660 2,294 2,589 2,772 Non-operating & Int. income (136) (266) (358) (422) (520) Others EO items 228 118 (168) 131 160 Depreciation 486 494 636 796 851 Working Capital Change (807) (748) (799) (753) (493) OPERATING CASH FLOW ( a ) 934 1,258 1,606 2,342 2,770 Capex (946) (804) (924) (900) (900) Free cash flow (FCFO) (12) 454 682 1,442 1,870 Investments 447 735 (12) 422 520 INVESTING CASH FLOW ( b ) (499) (69) (936) (478) (380) Share capital Issuance 24 17 29 - - Debt Issuance (42) 28 (27) - - Interest expenses Dividend (131) (324) (422) (688) (742) FINANCING CASH FLOW ( c ) (149) (279) (420) (688) (742) NET CASH FLOW (a+b+c) 286 910 250 1,176 1,648 Effect of Change in exchange rate 48 139 184 - -


KEY RATIOS FY11 FY12 FY13 FY14E FY15E PROFITABILITY (%) EBITDA Margin 15.2 17.4 18.2 19.4 18.3 EBIT Margin 11.1 14.2 14.8 15.7 14.7 APAT Margin 11.7 9.9 12.4 12.4 12.4 RoE 14.4 14.8 18.7 19.1 17.9 ROCE 14.5 14.8 18.7 19.2 18.1 ROIC 18.0 22.2 26.8 28.9 28.6 EFFICIENCY Tax Rate (%) 16.9 35.3 30.7 32.6 30.0 Asset Turnover (x) 1.15 1.34 1.42 1.44 1.36 Unbilled Days (days) 11 13.8 16.8 18.3 18.3 Debtors (days) 79 86 88 85 85 Payables (days) 23 33 39 40 40 Cash Conversion Cycle (days) 67 67.5 65.6 63.3 63.3 Debt/EBITDA (x) 0.018 0.013 0.001 0.001 0.001 Net D/E (0.37) (0.41) (0.42) (0.44) (0.48) Interest Coverage -- -- -- -- -- PER SHARE DATA EPS (Rs/sh) 12.64 14.49 20.69 24.35 26.24 CEPS (Rs/sh) 16.95 18.99 26.57 31.51 33.90 DPS (Rs/sh) 1.25 2.46 4.45 5.36 5.77 BV (Rs/sh) 92.51 103.88 118.47 136.68 156.30 VALUATION P/E 14.72 12.72 8.88 7.60 7.05 P/BV 2.00 1.78 1.56 1.35 1.18 EV/EBITDA 9.26 5.85 4.40 3.26 2.83 Dividend Yield (%) 0.7% 1.3 2.4 2.9 3.1 FCF Yield(%) (0.1) 2.2 3.3 7.0 9.0 OCF/EV (%) 5.6 7.9 10.7 16.9 22.7 FCF/EV (%) (0.1) 2.9 4.5 10.4 15.3


Page | 15


Disclaimer: This report has been prepared by HDFC Securities Ltd and is meant for sole use by the recipient and not for circulation. The information and opinions contained herein have been compiled or arrived at, based upon information obtained in good faith from sources believed to be reliable. Such information has not been independently verified and no guaranty, representation of warranty, express or implied, is made as to its accuracy, completeness or correctness. All such information and opinions are subject to change without notice. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete and this document is not, and should not be construed as an offer or solicitation of an offer, to buy or sell any securities or other financial instruments. This report is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by, any person or entity who is a citizen or resident or located in any locality, state, country or other jurisdiction where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject HDFC Securities Ltd or its affiliates to any registration or licensing requirement within such jurisdiction. If this report is inadvertently send or has reached any individual in such country, especially, USA, the same may be ignored and brought to the attention of the sender. This document may not be reproduced, distributed or published for any purposes with out prior written approval of HDFC Securities Ltd . Foreign currencies denominated securities, wherever mentioned, are subject to exchange rate fluctuations, which could have an adverse effect on their value or price, or the income derived from them. In addition, investors in securities such as ADRs, the values of which are influenced by foreign currencies effectively assume currency risk. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. HDFC Securities Ltd may from time to time solicit from, or perform broking, or other services for, any company mentioned in this mail and/or its attachments. HDFC Securities and its affiliated company(ies), their directors and employees may; (a) from time to time, have a long or short position in, and buy or sell the securities of the company(ies) mentioned herein or (b) be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as a market maker in the financial instruments of the company(ies) discussed herein or act as an advisor or lender/borrower to such company(ies) or may have any other potential conflict of interests with respect to any recommendation and other related information and opinions. HDFC Securities Ltd, its directors, analysts or employees do not take any responsibility, financial or otherwise, of the losses or the damages sustained due to the investments made or any action taken on basis of this report, including but not restricted to, fluctuation in the prices of shares and bonds, changes in the currency rates, diminution in the NAVs, reduction in the dividend or income, etc. HDFC Securities Ltd and other group companies, its directors, associates, employees may have various positions in any of the stocks, securities and financial instruments dealt in the report, or may make sell or purchase or other deals in these securities from time to time or may deal in other securities of the companies / organisations described in this report.

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Rating Definitions

BUY : Where the stock is expected to deliver more than 10% returns over the next 12 month period NEUTRAL : Where the stock is expected to deliver (-)10% to 10% returns over the next 12 month period SELL : Where the stock is expected to deliver less than (-)10% returns over the next 12 month period

Page | 16

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