Comments
The crash in technology stocks globally (including in India) this year has reminded investors of one old time-tested, hence validated, lesson in investing — fundamental valuations ultimately matter. Hardly any of the tech stocks have been sparred a correction this year after a euphoric rise last year. This is the case even when business momentum has remained robust (including in Indian IT across the board). Keeping this in mind, investors can book profits in the stock of KPIT Technologies which appears to have bucked the tech correction trend on a ytd basis, but may find it difficult to sustain it from here.
From its pre-Covid highs (January 2020), the stock has given returns of a whopping 600 per cent. During the same time, its net income (FY20-22) has grown by around 90 per cent. On a trailing basis its PE has expanded from around 19 times then, to 61 times now (up 220 per cent). Thus the significant part of the returns has come from PE multiple expansion. While some of this PE multiple expansion may have been justified by strong growth being delivered by the company, it appears to have got a bit excessive at current levels.
Trading at a hefty PE of 52 times FY23 earnings, the stock offers no margin of safety for company-specific and industry risks that can play out in 2023. FCF yield (FCF/market cap) of mere 0.43 per cent for FY23 also makes it unattractive and imply low cash flows relative to market value.
Further multiple expansion is unlikely to continue for the following reasons; one, rising interest rates make its valuation very unattractive. Near risk free debt investments are yielding close to 8 per cent in India, while the company’s FY23 earnings yield (1/PE) is a mere 1.9 per cent. Two, high exposure to western markets (35 per cent of revenue from the US, and 41 per cent from Europe), which are at risk of a recession in 2023, can impact its business, going forward.
The company derives over 90 per cent of revenues from the auto vertical (69 per cent of revenue from passenger cars segment and 24 per cent from commercial vehicles segment) which is highly cyclical and can take an outsized hit during periods of economic slowdown. This too is a risk to take cognizance of, now. Three, earnings growth too is tapering as base effect kicks in (even if the risks from economic slowdown are evaded), making it hard to justify current multiple. Thus the probability remains high that its valuation multiples will contract (as has already happened for most of the other IT stocks) and in a tapering earnings growth scenario, the risk-reward in the stock is unfavourable.
While for now the company’s business remains quite robust, overall it appears prudent for existing investors to take the chips off the table. The recent 35 per cent correction in the stock of peer company Tata Elxsi also sends across a message on the need for caution. New investors must wait and watch for significantly cheaper valuations and further insights on business and economic trends in 2023 before taking a call to enter the stock.
Recent performance
Our recommendation is entirely a valuation call, as the recent performance of the company has been quite good, and long-term prospects too look interesting. KPIT is well-differentiated within the Indian IT space given its niche focus. It is primarily engaged in the business of partnering with automotive and mobility clients in accelerating their transformation towards Software-Defined Vehicles. The automotive industry is gradually transitioning to what is termed a ‘CASE’ future. CASE is an acronym for connected, autonomous, shared, electric. KPIT is levered to these trends. The buzz around this space may have also been a factor in the stock outperforming peers.
KPIT’s solutions to clients involve prototype development, actual software development, validation and testing. Many of the leading global auto OEMs are in its clientele.
In the recently concluded Sep Q, the company reported revenue of ₹745 crore and EBITDA of ₹138 crore, Y-o-Y increase of 26 and 32 per cent respectively. Net profit of ₹84 crore was up by 28 per cent Y-o-Y. For the full year FY23, consensus estimates (Bloomberg), imply revenue and net profit growth of 30 (around 23 per cent organic growth) and 38 per cent respectively. The growth is expected to taper down to 23 per cent for revenue and 24 per cent for earnings in FY24. While this still reflects solid growth, current valuation of 52 times FY23 EPS and 40 times FY24 appears to be on the excessive side. While management in its Q2 conference call noted that they do not see any kind of slowdown in the immediate future, the recent outlook from leading US technology companies indicates that a slowdown is looming and investors need to plan for that possibility. Thus there may be risks to FY24 estimates.
Comments
COMMENT NOW
Comments
Comments have to be in English, and in full sentences. They cannot be abusive or personal. Please abide by our community guidelines for posting your comments.
We have migrated to a new commenting platform. If you are already a registered user of TheHindu Businessline and logged in, you may continue to engage with our articles. If you do not have an account please register and login to post comments. Users can access their older comments by logging into their accounts on Vuukle.