Cyient Ltd. share price target

It was a disappointing start to the year with overall revenue decline of 5.2% QoQ. Issues in large clients in aerospace & defence (A&D;) segment and communication segment continue to linger on growth in the recent quarter as well. Further, inferior execution also supported the decline. Services segment witnessed a drag of 6.1% sequentially (-3.4% YoY) to US$137.9 million which could suggests bottoming out of revenue decline. However, a recovery in Q2FY20E and beyond needs to be watched. Still, taking into account the considerable miss in revenue in Q1FY20 and limited visibility...

18 July 2019 revenue declined 2.6% YoY to USD157m (6% miss), EBIT was down 2.5% YoY to INR1.0b (margin of 9.2%, 200bp miss) and PAT increased 9.5% YoY to than our estimate of USD20m. Sequentially, revenue declined in all but the smallest vertical in Services segment the decline was particularly pronounced in Communications (-9% QoQ) and E&U; (-12% QoQ). CYL had guided for Services revenue growth in high-single-digits and DLM revenue growth of 15% in FY20. On the Services front, it now needs a CQGR of 3.3% to get even to flat revenue YoY. It expects EBIT to grow in double- digits, which too is a stretch now, despite the cost-rationalization efforts. While 1Q was expected to be a weak quarter, CYL misread the recovery in A&D; and Communications, its two largest verticals (57% of revenues) that were expected to offset the anticipated weakness in other segments.

As much as 15% of US exports to China comprises aircraft. Hence, ongoing trade friction between US and China adds risk to Cyient's core vertical, Aerospace & Defense (34% of rev). Cyient's other key verticals like communications (-1.8% 4Qtr CQGR) can revive based on deal wins. Transportation will remain strong (2.2% 4-qtr CQGR; Cyient works for top-5 European rail cos). Cyient is struggling with issues such as (1) Single digit growth in services business, (2) Challenges in top accounts (3) Issues in core vertical (Aerospace & Defense), (4) Higher growth from the low margin DLM business (~4.0% in FY19), (5) Reducing scope of margin expansion in services due to higher investments, and (6) Higher other income (~22% of PAT vs. 11% for LTTS). We expect USD revenue/EPS CAGR of 8.6/8.8% over FY19-21E. The stock trades at 11.7x FY20E which is at ~50% discount to LTTS. This steep valuation gap will persist, given LTTS' higher growth, better margin profile and superior return ratios. Downgrade to NEUTRAL. Our TP of Rs 595 is based on 11.5x FY21E EPS. Cyient has lagged peers (ER&D;) in most parameters, viz. growth, margins and top accounts performance. Co grew 8.6% in FY19 (vs. 24.6% for peer co LTTS), top-5/10 accounts were down 2.2/1.7% YoY and EBITDA margin stood flat at 14% (vs 18% for LTTS). Cyients higher mix of mechanical engg services explains the slow growth and lower margin. According to Zinnov, Non-Digital ER&D; services (mostly mechanical) are expected to grow at just ~3% over the next five years.

CYL also reiterated its S3 strategy, New Business Accelerators (NBA) program and its transformation into an end-to-end Tier-1 solutions provider to drive sustainable growth. It has higher focus across embedded software, connected assets, mechanical manufacturing and DLM for the same....

Cyient Ltd. reported flat results in terms of top line and in terms of operating margins in Q4FY19. Cyient posted revenue growth of 0.1% on QoQ basis in constant currency terms for the period of Q4FY19.

We believe revenue to grow at a CAGR of 8.7% over the period of FY19-FY21E. We expect execution of pushed out deals and investments made in developing new technology solutions to contribute significantly to the revenue growth in the coming years.

Sector: IT /Mid-Cap | Earnings Update 4QFY19 Background: Cyient is a mid cap IT company with revenue of INR 46.2bn (FY19) specializing in engineering solutions, including product development and life cycle support, process, network & content engineering. In 4QFY19: revenue share from Americas (49.6%), Europe, Middle East, Africa (22.6%), and Asia Pacific (27.8%). Revenue share by business unit: Aerospace and Defense (36.4%), Transportation (11.7%), Semiconductor (5.0%), Medical & healthcare (3.3%), Utilities & Geospatial (13.5%), Communication (20.0%), I&ENR; (9.2%). Revenue contribution from Top 5 clients (31.8%), and Top 10 clients (43.0%), Total employees stood at 15,084....

Cyient's growth engine is challenged given client specific issues. Large verticals, Aerospace and Communications are taking longer than expected to recover. Further margins expansion will be difficult considering investments required in the business and tight labour market. We expect USD revenue growth of 7.8/9.3% and EBITDA% of 14.0/14.2% for FY20/21E. The buyback of Rs 2bn is completed at an average price of Rs 640/share. Net Cash stands at Rs 7bn (~10% of Mcap). The stock trades at reasonable valuation of 12.4x FY20E which is ~49% discount to LTTS. Risks to our thesis include prolonged issue with top clients and slowdown in DLM. We maintain BUY on Cyient based on in-line 4QFY19. Given the single digit growth in services business, we cut P/E multiple to 14x vs. 16x earlier. Our TP Rs 725 is based on 14x FY21E EPS.

Revenue growth expected to be more back ended FY19 services revenues were in single digits i.e. 7.6% vs. guided double digit growth at the start of the year & lower than the revised guidance (of 8.5%9.5%) in Q3FY19. This was mainly due to lack of talent availability and demand deferral by large client in the A&D; and communication segment. The company is addressing talent specific issues and has also incorporated risks on the demand front in providing guidance. The company also has a healthy book to bill ratio of 1.29x in Services and 1.07x in DLM business leading to overall book to bill ratio of 1.26x. As a result, the company expects...