Indian ESPs Display Robust Revenue Growth Amid Slow Quarter Challenges/Pixabay
Indian ESPs Display Robust Revenue Growth Amid Slow Quarter Challenges
Engineering Service Providers (ESPs) in India exhibited strong revenue growth despite challenges in a traditionally slower quarter, according to Kotak Institutional Equities. The automotive sector faced a growth slowdown, yet automotive Original Equipment Manufacturers (OEMs) are expected to maintain high spending levels in 2024. Earnings Before Interest and Taxes (EBIT) margins remained steady for most companies. While concerns about stretched valuations linger, Cyient stands out for its improved business portfolio and relatively reasonable valuation, preferred by Kotak.
Q3FY24 Earnings Overview: Mid-Cap IT Stocks
- Healthy Revenue Growth: Pure-play service providers in the Engineering Research and Development (ERD) sector sustained steady growth in Q3FY24. KPIT led with a QoQ growth of 4.3%, followed by Tata Elxsi and Cyient with growth rates of 3.0% and 1.1%, respectively. L&T Tech experienced modest growth at 0.9%, while Tata Tech’s services revenue declined by 0.5% QoQ.
- Dichotomy in Automotive Spending: Automotive vertical growth moderated due to higher-than-expected furloughs and moderation in spending by tier-1 suppliers. ESPs with strong OEM relationships, like KPIT, benefitted from healthy spending. Tata Tech’s revenue growth was impacted by the accelerated ramp-down of the Vinfast account.
- Improved CY2024E Outlook: Challenges persist in industries like telecom, media, hi-tech, and medical devices. However, signs of potential improvement are noted, especially in the hi-tech sector. Sustainability remains a key priority, offering growth opportunities for companies focusing on sustainable solutions, such as L&T Tech and Cyient.
- EBIT Margins Remain Range-Bound: Cost optimization efforts have delivered positive outcomes across ESPs. Tata Elxsi and Cyient saw a margin decline of 30-50 bps, attributed to various factors. Tata Tech witnessed a significant improvement in margins, up by 140 bps QoQ, while LTTS and KPIT saw EBIT margins increase by 10-60 bps.
- Cyient Preferred Pick; Cautious on Others: Kotak remains cautious due to stretched valuations, impacting the outlook for L&T Tech, KPIT Technologies, Tata Elxsi, and Tata Technologies. However, Cyient is preferred by Kotak, given its reasonable valuations, strategic positioning, and focus on sustainability.
Outlook and Recommendations
The growth outlook for FY2024E is influenced by industry challenges, but potential improvement is expected in certain sectors. Cyient’s reasonable valuation and strategic focus on sustainability make it Kotak’s preferred pick. Despite challenges, Indian ERD service providers are well-positioned to benefit from ongoing technology transitions.