KPIT Cummins Infosystems: Buy

Investors with a two-year horizon can buy the shares of KPIT Cummins Infosystems (KPIT) in light of the robust growth in its main segments of operation. Strong uptick in its key manufacturing vertical, lucrative large-client additions and improvement in performance metrics are positives for the company. KPIT has also been actively pursuing growth through the inorganic route. At Rs 163, the share trades at 11 times its likely FY12 per share earnings. This is at a discount to mid-tier players such as Hexaware and Infotech Enterprises. The cash per share of Rs 29 also offers cushion to our recommendation.

After a difficult couple of fiscals, the company has rebounded substantially in FY11. During 2010-11, KPIT's revenues grew by 39.8 per cent to Rs 1,023 crore, while net profits rose 10.3 per cent to Rs 94.6 crore.

Large segments grow

The manufacturing vertical, which comprises automotive, Hi-tech and Industrials segments, contributes over three-fourths of the company's revenues. Growth of nearly 30 per cent in this vertical in FY11 bodes well for KPIT. Within the automotive segment in this vertical, a revival in car sales around the world, specifically the US, on the back of governmentstimuli has helped KPIT's clients increase spends. Also, the trend of increasing the electronics portion of cars to make them smarter and greener, has helped.

KPIT has also deepened its relationship with the automotive sector in India and China where passenger car sales are at robust levels. The company claims to be the largest third party vendor in India in auto-embedded electronics. Even the core industrial segment has witnessed a revival. This is borne out by the fact that revenues from Cummins , the company's top industrial client, grew by 5.5 per cent over FY10.

From a geographic perspective, the US, which accounts for two-thirds of the company's revenues, has clocked close to 57 per cent growth in revenues. This revival becomes significant as most top and mid-tier IT companies have witnessed a surge in projects from the North American region, with BFSI, manufacturing and retail sectors leading the way. Although Europe, due to the challenging economic environment there, slid, it was made up by the spike in contribution from the rest of the world, mainly from India. The company's acquisition of CPG Solutions and Sparta Consulting has improved KPIT's enterprise solutions offering, with the former enabling more project wins from Cummins.

KPIT has also increased its focus on the Indian defence sector, what with expected increased spends on modernisationprompting even large IT players to look at this segment closely for IT outsourcing opportunities. KPIT has already won a deal from one defence organisation.

Key metrics improve

The company has posted robust client additions in FY11, with as many as eight new ones coming from the $1 million plus category. This enhances revenue visibility as larger denomination deals tend to come with better margins and also play out over longer timeframes. This apart, the top clients of the company have enhanced contribution at a robust pace. KPIT has also rationalised or let go of some low-value clients to prop up margins. There has also been a significant improvement in fixed price deals. Such projects which contribute about 31 per cent of revenues ensure better realisations than time & material based ones. KPIT is also looking at a 3-5 per cent increase in pricing, which compares favourably with peers and even larger IT players. This should aid margins. The company's utilisation, which is at 68.5 per cent currently, offers substantial scope for improvement on the back of increased volumes, at least to the tune of 3 percentage points.

KPIT also plans to increase its offshore proportion of revenues, up from its 56 per cent levels presently. The company has indicated that it would bring more of the ERP-related work offshore, which would optimise costs.

Attrition at over 21 per cent continues to be high for the company and is a key execution risk. Any salary hike beyond the 12-14 per cent that has been given in April to stem increase in attrition may affect margins.

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