Equity Research: Cyient Ltd

Summary

Cyient Ltd looks attractive at CMP for further upside potential of 38% by FY24 due to favourable global market sentiment and increasing order book.

Cyient is an Indian multinational technology company that is focused on engineering, manufacturing, data analytics, and networks and operations. Infotech Enterprises Ltd. was established in 1991 in Hyderabad. Infotech Enterprises was re-branded as Cyient in 2014 and was featured among the top 30 outsourcing companies in the world in 2018.

The last three quarters have shown growth for Cyient's Services (11% organic), although it still lags behind its competitors (LTTS rising 16.4% y/y). Orders were $141 million, up 18% year over year, with average quarterly increase of 13 to 15%. Supply constraints kept DLM at $25 million, up just 1% year over year. In FY23, Cyient continues to aim for organic growth of 13–15%. Due to the company's investments in wages and hiring (lower utilisation), the EBIT margin decreased to 11.5%, although the estimate for the full year's margin remained steady at 13–14%. Organic growth in services was 1.1% q/q, driven by communications (9% q/q), portfolio (2.5%), and aerospace (0.2%; rail and utilities were flat to down). With Aerospace anticipated to rebound by H2, future growth is likely to follow this pattern. Services orders reached a high of 6-7 quarters with an increase of 18% y/y and 13% y/y on a TTM basis. In Q1 the company completed six large transactions (four from services, two in DLM). Citec and Celfinet will contribute from acquisitions starting in Q2 of FY23, while Grit contributed in part in Q1. In order to advance an auto contract, Cyient also paid Rs 850 million for a division from Klaus IT. Due to reduced utilisation (80.9%; down 520bps q/q, 220bps y/y) and larger salary increases (the biggest in Q1), Cyient's Q1 EBIT margin was lower. It also increased SG&A expenditures for growth. Cyient has had significant SG&A costs for several years, but very modest growth. Offshoring increased operationally to 50% (up 160bps q/q and 270bps y/y), which is important because lower utilisation allows it room to more cost-effectively manage growth.

Due to the disappointing results in Rail and Utilities in Q1, the firm only experienced ordinary industry growth. But Cyient continues to see success with its communications division. Comparing Cyient to its competitors, there is still much ground to cross (LTTS Q1 FY23 increasing 3.2% q/q, 16.4% y/y), but the performance gap is gradually closing. If the company's most recent purchase succeeds, it might experience stronger growth.  After three years, Cyient's Services business gained year over year for a fifth straight quarter in Q1 FY23, regaining growth momentum. According to the management's order intake, the growth momentum will be maintained. At the corporate level, it has predicted growth of 13–15% in constant currency. The company had a strong quarter in terms of order intake, with Q1 at $141m (up 18% y/y). It is noteworthy that over the past seven quarters, orders received have outpaced revenues booked, and the company's main industry, A&D (up 8% y/y), has resumed growth. Due to vendor consolidation, currency fluctuations, and increased outsourcing, rail (down 21% y/y) continues to be a drag. The second and third largest segments for Cyient at the moment are these two. Over the past five quarters, TTM-based revenues and TCV have been increasing. Cyient signed six sizable contracts in Q1 with a TCV potential of $424.3 million (four in services and two in DLM). Cyient signed seven sizable deals in Q4 with a TCV potential of $134.9m (six in services and one composite B2S).

Growth in Service Sector:

The two key verticals that make up Cyient's Services are aerospace (24% of revenue) and communications (30%). Aerospace saw an 8% y/y growth, but a flat q/q growth. The aerospace industry is expected to rebound by H2, according to management. The company has seen promising developments in the fields of defence, space, hybrid, urban air mobility, and electrification. Two logos were added by Cyient to urban air mobility. Before the pandemic, this sector contributed the most to overall revenue. Communications experienced 9% q/q and 15% y/y growth in Q4 and is anticipated to continue this trend going forward. The business is excited about network modernization and transformation in the areas of wireless, 5G, and fibre.

Higher Attrition and better manpower addition:

In the past twelve months, Cyient added 1,755 employees (Sservices, of which 747 were hired in Q1), which caused utilisation to decline to 80.9% in Q1 FY23 (from 83.1% in Q1 FY22). Although growth was relatively unimpressive in Q1 compared to Q4, hiring increased, which is surprising and might be related to the concentration on M&A. The business did not disclose any hiring goals for FY23, but it has assembled a pool of engineers who are prepared to start working in Q2 and Q3. On a quarterly annualised basis on an LTM basis, attrition has increased to 27.9% and 30.4%, respectively. Although this is the company's greatest attrition rate, it is quite consistent with the sector average. In terms of employee productivity, Cyient is consistent with its previous history (as of Q4 FY21), and any minor differences result from hiring in recent quarters. From a utilisation standpoint, it looks like the company has headroom to help profits in the future. Offshoring can provide margin tailwinds and is still favourable as a lever compared to the industry.

Due to significantly slower growth and dropping margins to 15.6% (251bps q/q), Cyient experienced lower EBITDA growth in Q1 than the sector as a whole (down 8.8% q/q but up 3.6% y/y). Offshoring increased although utilisation decreased, which we consider to be good news for the business. The first shows growth optimism and a slight bias in favour of newcomers, but the second is favourable from the standpoints of margin and competitive advantage. Even if the headcount is still below its peak, it has begun to increase significantly during the past few quarters. The company had an 11.5% EBIT margin in Q1 (down 296bps from Q2 to Q3 and 164bps from year over year). Cyient predicted FY23 EBIT margins of 13–14%, which are comparable to FY22's after adjusting for reopening, M&A-related, and other costs.

Cyient to get royalty income:

Cyient was developing SDR for a large opportunity from the department of defense (India). Cyient decided to let specialized player, ICS takeover this product. Cyient will get 15% stake in ICS and Cyient DLM will remain their manufacturing partner after the deal. Cyient will also earn a royalty because of the product given to them. An advantage of this divestment is that the company no longer has an obligation to restrict foreign ownership to 49%. SDR arrangement had an outflow of Rs.100m in exchange for the 15% stake. Cyient has transferred the technology and the product will be finished by ICS. 

Historical Financials:

Estimated Financials:

Valuation:

The stock trades at 14x FY24E EPS. Revenue grew 9% in FY22, slower than the industry on account of gradual recovery in Aero and sustained weakness in Rail. DLM also suffered on account of chip shortages toward the year’s end. However, the company seems to be returning to growth, with the deal momentum picking up on the Services side, more so in the Communications vertical, which is now its largest Services vertical. Overall, Cyient recorded double-digit growth in Services in Q1 FY23 for only the second time in nearly three years. The EBIT margin expanded 380bps in FY22 (13.9%) but is expected to slip to 13% in FY23 before stepping up to 13.3% in FY24. We expect the price of Cyient to grow 38% upside from it CMP of Rs. 742 to Rs. 1024 by FY24.