March 2, 2023
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CYIENT, Challenges ebbing steadily – re-rating on the cards
Call & Research Report by Motilal Oswal
Sector: IT Services & Consulting
CMP Rs. 966, Target Rs. 1170 (21% upside potential)
Target Period: 12 Months
● Cyient (CYL)’s operating performance has inherently been subdued over the past several years as a few of its growth engines remained weak and underperformed that of its peers. In addition, execution challenges have marred the company’s overall topline growth.
● According to the management, the challenges under Aerospace and Communications segments (~50% of service revenue) have bottomed out and these segments are likely to improve and stimulate overall organic growth (guided at 13-15% in constant currency (CC) terms) in FY23E. Additionally, its revenue growth should also amplify led by the inorganic components (~14-15% of FY23E revenue) and gradual recovery in its Design Led Manufacturing (DLM) business (guided high single-digit CC growth).
● Management aspires to reach USD1b revenue run-rate for the consolidated entity with 15.0-15.5% margins by 4QFY24 exit. With the given aspiration, it requires the company to deliver ~5% CQGR over the next five quarters along with ~200bp margin improvement at 4QFY24 exit v/s 12.9% in 3QFY23. We consider this as a bull case scenario that has an upside risk over our base case.
● Based on the above thesis, the bull case scenario is seeing an EPS upgrade of ~3% and ~15% over the base case in FY23E and FY24E, respectively. The revised EPS translates into P/E multiples of 18x and 12x EPS of INR53.7 and INR78.7, respectively. If the bull case scenario turns out to be positive, CYL would have a significant re-rating potential. If CYL trades at 17x FY24E EPS of INR78.7 that would translate into a substantial 38% upside from current level.
● However, our base case still remains the same given the ongoing macro headwinds and the company level execution challenges. The current valuations at 18x/14x FY23E/FY24E EPS of INR51.9/INR68.6 appear highly attractive giving us more comfort to maintain our BUY rating. Our target multiple of 17xFY24E EPS implies a TP of INR1,170, with 21% potential upside.
Key service verticals to support incremental growth
● CYL has reported organic service revenue CQGR of 2.4% between 1QFY22 and 3QFY23 despite the Aerospace, Rail and Communication (ARC) segment remaining soft, which reported a 0.9% CQGR during the same period.
● The softness in ARC was attributed to the Rail Transport. The revenue contribution from Rail has significantly tapered-off to 6.2% in 3QFY23 from 13.5% in 1QFY22, clocking a negative CQGR of ~7%.
● With the company indicating a bottoming out in Rail business in 4QFY23, CYL should see a positive impact on overall FY24E revenue. We expect this to result in an overall revenue growth delta of ~2.5-3.5% in FY24.
● The MRO and Maintenance services that contribute ~40% each to the Aero vertical is picking up well with the increase in Air traffic volume, while the positive momentum continues for design-led services (20% of Aero) on both commercial and defense domains.
● With the acquisition of Citech, the company has made its way by adding the new vertical line (Plant & Product Engg.) to its diversified business mix, while expanding its footprint in the Nordic countries. The acquisition is likely to add ~USD100m+ to its topline in FY24.
● While DLM has underperformed the company’s expectations in the past, we expect the business outlook to remain supportive on account of the imminent improved electronics manufacturing ecosystem in India. Moreover, dedicated leadership and a potential listing should result in more focused go to market and client mining. This can also act as a potential upside to CYL’s valuation (not in our base case though).
Valuation and Views:
● CYL’s service segment is shaping up quite well with a majority of its growth engines (excluding Rail, Consulting and Utility) sustaining the positive momentum and delivering robust growth of 15% YoY in 9MFY23. Conversely, other segments are on the verge of recovery and should incrementally contribute to its overall growth in FY24E.
● With DLM, the value unlocking may come through after the carve-out of the business. The change in the leadership structure and decoupling of the business would incrementally add value to CYL’s earning profile.
● Given the ongoing macro headwinds and the company-level execution challenges, we remain watchful of the company’s earnings growth trajectory.
● However, the current valuations at 18x/14x FY23E/FY24E EPS of INR51.9/ INR68.6 appear highly attractive giving us more comfort to maintain our BUY rating. Our target multiple of 17xFY24E EPS implies a TP of INR1,170, with 21% potential upside.
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