L&T Technology Services (LTTS) reported significantly better-than-expected Q3FY18 with growth in USD revenues of 8.3% q-o-q and 25.6% y-o-y. Growth was reasonably broad-based across segments, barring Industrial Products which saw a sequential decline primarily led by furloughs. Management expects revenue growth in FY18 to be at least 18% (implied growth for Q4FY18 of “at least 1.5%” q-o-q) and FY19 revenues to grow in double-digits. Ebitda margins were flattish q-o-q at 15.3% and a tad shy of estimates with wage hikes and higher subcontracting costs being the key drags. However, we see multiple levers including pyramid rationalisation, higher offshoring and fixed cost absorption to help margins to gradually trend back to at least 16% in FY20. Attractive hedge rates should help provide below the line support to earnings till FY20. Maintain Add rating with a target price of Rs 1,042. Target multiple raised to 17.5x given superior revenue execution and better quality of revenues relative to similarly sized IT services peers.
Telecom vertical leads growth; Industrial products weak on seasonality; Process recovers after 8 consecutive quarters of weakness: Revenues from the telecom vertical (USD terms) increased by 24.8% q-o-q and now constitute 27.9% of overall revenues. Growth was broad-based within telecom across the sub-segments of consumer products, semiconductors, Media & entertainment and Telecom OEM. Revenue from Industrial products (21.8% of revenues) declined by 0.3% q-o-q, given the impact of furloughs. Process engineering revenues, after being weak for 8 consecutive quarters, witnessed a sharp recovery in Q3FY18, growing 7.8% q-o-q. Growth in the segment was again broad- based across CPG, O&G and Specialty chemical sub-segments. Transportation continues to be the largest vertical for LTTS constituting 30.9% of revenues and posting q-o-q growth of 3.7%.
Strong deal wins and pipeline lend enhanced visibility to double-digit revenue growth in FY19: Though LTTS stopped sharing quantitative data on order backlog and qualified pipeline, management remains confident on continuity of double-digit revenue growth in FY19. LTTS won 6 large deals in the quarter including a $50-mn, 5-year deal in the aerospace vertical for in-flight entertainment systems. The company is also in the final stages of winning a large deal with a Europe-based global oil major. Success of mining initiatives around the company’s T30 strategy also gives management confidence on continuity of growth.
Strong mining evident in client metrics: Two clients now contribute more than $40 mn in annual revenues on a run rate basis (vs none in Q2FY18) with 2 clients contributing more than $30 mn (vs one in FY17). Growth in Q3FY18 was broad-based across client buckets with Rupee revenues at top5, top6-10, top11-20 and nontop-20 clients increasing by 15.6%, 2.6%, 8.3% and 4% q-o-q respectively.