Thursday, February 16, 2012

>NIIT TECHNOLOGIES: Low valuations; High potential

We initiate coverage on NIIT Technologies (NITEC) with a Buy rating and one-year Target Price of `290. In our opinion, the current stock prices do not factor in the growth potential and visibility provided by the increased order book. NITEC has been benefiting from its long-term focus on niche verticals of BFSI and transportation, an evidence of which is visible in its marquee client base and recent large-sized deals won by the company. We expect revenues (in US$ terms) and earnings to grow at CAGR of 18% and 15%, respectively over FY12-14E, with stable profit margins. We believe the current valuations of 7.1x and 6.0x its FY12E and FY13E earnings, respectively are inexpensive with a 3.4% dividend yield offering further comfort.

 Valuations not factoring growth opportunities
The CMP of `233 ascribes a meager 22% value to future growth opportunities for NITEC. This is materially lower when compared to large as well as mid-tier peers in the industry. In our opinion, the market expectations of low growth in NITEC’s future earnings are unduly pessimistic, especially considering an order intake of US$361mn in 9MFY12 compared to US$266mn in entire FY11. More importantly, the order book executable over the next 12 months has risen from US$169mn at the beginning of FY12 to US$245mn at the end of Q3FY12. Historically, the ratio of revenues to the order book executable at the beginning of the year has been in the range of 1.8x to 2.6x.

■ Long-term client relationships with niche vertical focus
Since its inception, NITEC has had an exclusive focus on BFSI and transportation verticals. Revenue contribution from these verticals has been gradually increasing and was ~73% in FY11. The company has established long-term relationships with marquee clients in these verticals which include names like British Airways, Sabre, SEI, Cathay Pacific, Virgin Group, ING and AXA. NITEC has also been diversifying its client base as number of clients contributing >US$1mn in revenues has increased from 32 in FY10 to 56.

■ Healthy revenue and earnings trajectory
Driven by strong order book, we expect revenues (in US$ terms) for the company to grow at a CAGR of 18% over FY12-14E. Our FY13E revenue estimate of US$397mn is 1.6x (vs the 1.8x-2.6x historical range) the executable order book of US$245mn at the end of Q3FY12. EBIT margin is expected to remain stable in 15-16% range with multiple levers like increasing share of non-linear offerings, offshore leverage and broadening of employee pyramid. After a muted performance in FY12 because of higher tax rates, we expect earnings to grow at a CAGR of 15% over FY12-14E. We have assumed exchange rate of `48.5/US$ and `47.5/US$ for FY12E and FY13E, respectively. Our conservative revenue and margin estimates provide room for upward revision in estimates in future.

■ Asset heavy and working capital intensive deals pose a risk
NITEC participates in deals that involve takeover of existing technology infrastructure assets and workforce. The company also participates in government deals that require it to supply technology hardware for the project. The execution risk profile and working capital requirements in such deals are higher than normal IT services projects. The company saw its FY11 working capital rising because of such deals.

 A preferred play in mid-tier space; initiate with Buy
We have valued the company at 7.5x its FY13E earnings yield at one-year Target Price of `290. We expect the company to announce a dividend per share of `8 for FY12 resulting in a lucrative dividend yield of 3.4%. In our view, strong growth visibility coupled with attractive valuations makes NITEC a good investment candidate amongst mid-tier technology companies. Hence, we initiate coverage on NITEC with a Buy rating and a Target Price of `290.

To read full report: NIIT TECHNOLOGIES