Sonata Software: Solutions at a click

Given the highly volatile market prevailing now, investors would be better off taking highly selective defensive bets, instead of bottom fishing in cyclicals.

In this regard, mid-tier IT services player Sonata Software appears a reasonable bet for investors with a two- to three-year horizon.

An increasing proportion of revenues from international locations, a focussed approach that targets a limited set of verticals and the drive to expand IP solutions are key positives for Sonata. The company also has a solid domestic presence, with a large proportion of its revenues coming from India.

Sonata also pays fairly healthy levels of dividends consistently. The stock’s dividend yield has been in excess of 3 per cent over the past few years.

At ₹369, the stock trades at 14 times its likely per share earnings for FY20, which is at a discount to most mid-tier IT players, which trade at 18-20 times future earnings.

Between 2015 and 2018, Sonata’s revenues grew at a compounded annual rate of 13.4 per cent, while net profits increased at 12.7 per cent. The company recorded revenues of ₹2,454 crore in FY18, while net profits stood at ₹188 crore.

The company’s return-on-equity has been healthy, and was a robust 31 per cent in FY18, which compares favourably with most mid-tier peers.

Diversified focus

Sonata derived around 62 per cent of its revenues from India in FY18. The company mostly distributes software products and delivers related services to domestic clientele. The local business generates relatively lower single-digit margins for the company, but revenues have been growing at a slow, but steady, pace over the years.

It is in the international business that Sonata’s offerings have met with considerable traction over the past four to five years. The proportion of revenues from its international IT services business has increased from 32 per cent in FY17 to 38 per cent now. Revenue growth in the segment has been in the mid-teens in recent years, a rate that is among the best in the industry.

The EBITDA margins in its overseas offering are in excess of 20 per cent.

Apart from offering services to select verticals such as retail distribution and travel, Sonata partners with independent software vendors (ISVs) such as Microsoft and SAP and delivers solutions to clients.

The ability to focus on a select set of segments and deliver solutions has helped the company execute projects for overseas clients successfully, and derive more customer references with partnerships.

Platform-led strategy

The company has a significant partnership with Microsoft, apart from Oracle and SAP, and has been able to win a considerable number of deals overseas due to these associations. In fact, over the past one year, the company has had over 30 deal-wins in Europe and APAC geographies due to the tie-ups with Microsoft, as it had a well-defined go-to-market strategy. Sonata has increasingly focussed on delivering solutions to clients through the platform route.

The company calls it the ‘Platformation strategy’, wherein a solutions-based approach for servicing clients with platforms, digital transformation and IP-led offerings are the thrust areas.

From 14.7 per cent of the international IT revenues in June last year, IP offerings now contribute 16.3 per cent of the overseas pie.

IP-led solutions typically result in higher margins as these offerings are not linked to deployment of headcount in a project and are preferred by many customers.

Sonata is also making inroads into the digital space. Around 33 per cent of its revenues from the international IT services segment now come from digital offerings, and have been growing at a faster pace than the company’s overall growth rate.

Revenues from its top 20 per cent customers have grown at a healthy pace over the past one year, indicating that the company has been able to mine existing clients well.

Operationally, Sonata’s utilisation, at 85.7 per cent in June 2018, is among the best in the industry and much higher than that of most mid-tier IT players.

The number of million-dollar clients has increased by 3 over the past one year to 24 now in its international IT services business.

One concern for the company has been the steady increase in attrition, which stood at 18 per cent as of June 2018. Any significant wage hikes given to stem the rate could affect margins.

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