L&T Infotech: Well-coded

The year FY19 has been a promising one for most Indian IT players, with revenue growth almost touching double digits in some cases. In this light, mid-tier IT player L&T Infotech (LTI) keeps going at 1.5 times the industry’s rate generally. But in 2018-19, it grew more than twice the industry and top-tier software services players, in dollar terms.

From our recommendation little over a year ago, the stock is up over 20 per cent. But it may still have legs to climb much higher and outperform the broader markets.

A steady rise in the proportion of digital revenues, increasing contributions from high-margin offerings, traction in its large verticals and healthy large-deal wins are positives for the company. Key metrics such as utilisation and attrition have also improved.

The stock (at ₹1,696) trades at a little over 15 times its likely per-share earnings for FY21, cheaper than the multiples that Mindtree trades at (over 16 times) and at par with many mid-tier players, despite LTI enjoying a much larger scale and superior margins. If the company is able to sustain its industry-beating performance, there may be scope for re-rating of the stock.

Investors with a two-year perspective can consider buying the company’s shares.

In FY19, LTI’s revenues rose 29.3 per cent over the same period in FY18 to ₹9,446 crore, while net profits went up 30.5 per cent to ₹1,516 crore. In dollar terms, the revenue growth was 19.1 per cent, more than twice that of top-tier peers such as TCS and Infosys, and much ahead of the overall industry rate.

Digital drive

L&T Infotech has steadily increased the scope of its digital services offering. Digital revenue now accounts for 38 per cent of its overall pie, up from around 33 per cent as of March 2018.

This proportion is among the best in the industry, as even the bluechip names derive only around 25 per cent of their revenues from digital offerings.

The company’s higher-margin offerings such as enterprise solutions, analytics, AI and cognitive, and enterprise integration and mobility have grown at a much faster pace than LTI’s revenue rate. The growth rate for these service lines was 25-36 per cent in FY19. These offerings account for nearly 46 per cent of the overall revenue.

LTI has reduced its focus on traditional low-margin application services, infrastructure management and testing. But these offerings, too, have grown at a double-digit pace. Thus, the service mix is fairly optimal.

As a result, even as realisations come under pressure, the company has still been able to improve its EBITDA margins to healthy levels of around 20 per cent, up from about 17 per cent in the previous fiscal.

Large verticals

All of LTI’s verticals have been growing. Large segments such as BFS (banking and financial services), manufacturing, hi-tech, CPG (consumer packaged goods), retail and pharma grew at 12-35 per cent Y-o-Y in FY19.

Revenues from key geographies such as North America and Europe have been improving steadily.

Interestingly, India is a very significant region for LTI, accounting for more than 7 per cent of its revenues.

Thus, the company’s growth trajectory has been sustained due to the broad-basing of its revenue streams.

Key metrics improve

In the last one year, LTI has been able to add one new customer in the $50-million category, four in the $20-million bucket, and three in the $10-million band. These wins suggest that the deal pipeline has been fairly steady.

Despite the trend of companies having to recruit on-site, with the governments in the US and many European countries insisting on hiring locally, the proportion of LTI’s on-site efforts is still under 22 per cent, among the best in the industry.

If there is greater demand to deliver projects from client locations overseas or to hire locally, there is still reasonable leeway for the company to do so without having to face a dent in its margins.

Utilisation, at 81.1 per cent, has been steady, and compares favourably with most peers.

Attrition, a key operation risk, has been increasing in recent quarters and is at 17.5 per cent currently.

With many of the special economic zones where it operates moving out of the exemption phase, the effective tax rate is expected to increase from 23 per cent to 25 per cent over the next couple of years.

One key development to watch out for is L&T’s bid for Mindtree. L&T has made it clear that LTI and Mindtree would not be merged in the near future.

But such a move cannot be ruled out, say, a couple of years down the line.

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