PRICE: RS.75 RECOMMENDATION: ACCUMULATE
TARGET PRICE: RS.90 CY10E P/E: 3.3X
R Systems' 3QCY09 results were a mixed bag. While revenues were
marginally lower than estimates, PAT came in higher due to nonoperational
factors. Client specific issues impacted revenues during the
quarter. Lower provision for gratuity and leave encashment led to higherthan-
expected EBIDTA and net profits. Scale down from important clients
continued during the quarter. The quarter validates our concerns relating
to early - stage customers and vendor rationalization impact for smaller
companies like R Systems. We expect macro headwinds and client-specific
issues to impact growth rates in 4QCY09, before the performance improves
in 1QCY10. We make changes to our CY09 estimates and introduce CY10
earnings; EPS expected at Rs.22 and Rs.23, respectively. We retain
ACCUMULATE with a price target of Rs.90 (Rs.84 earlier), only based on
valuations and cash in the balance - sheet. Net cash of about Rs.66 per
share may act as cushion. We will become more positive post sustained
improvement in macro-scenario and continue to prefer large caps. A
delayed recovery in major user economies and a sharper-than-expected
appreciation in rupee v/s major currencies are the primary risks to our call.
3QCY09 results
(Rs mn) 3QFY09 2QCY09 QoQ (%) 3QFY08 YoY (%)
Income 786.7 824.9 -4.6 921.1 -14.6
Expenditure 687.1 741.2 810.6
EBDITA 99.6 83.7 19.1 110.5 -9.9
Depreciation 35.8 35.3 30.3
EBIT 63.9 48.4 80.3
Interest 2.1 0.5 1.4
Other income 22.3 0.5 -5.4
PBT 84.1 48.4 73.9 73.6 14.3
Tax 0.6 1.9 8.0
PAT 83.5 46.5 79.6 65.5 27.3
EO items -7.1 -208.7 0.0
Shares (mns) 12.2 12.2 13.4
EPS (Rs) 6.8 3.8 4.9
Margins (%)
EBDITA 12.7 10.1 12.0
EBIT 8.1 5.9 8.7
PAT 10.6 5.6 7.1
Source : Company
Revenues fall short of expectations
n Revenues de-grew by 5% QoQ (8% QoQ fall in 2Q) in INR terms and came in
below our expectations.
n Volumes were down by about 5% and this was the third successive quarter of
substantial volume de-growth (5% and 8% QoQ fall witnessed in the previous
two quarters).
n A couple of large accounts of acquired subsidiaries had indicated their intention
to scale down business with R Systems and these impacted revenues.
n One large customer has gone for re-structuring (after incurring a huge loss) and
wants to consolidate vendors. Another customer has sold off part of its business
and has also terminated the relationship with R Systems.
Summary table
(Rs mn) CY08 CY09E CY10E
Revenues 3594 3275 3206
Growth (%) 45.5 -8.9 -2.1
EBITDA 463 407 401
EBITDA margin (%) 12.9 12.4 12.5
Net profit 283 279 283
Net cash (debt) 604 700 934
EPS (Rs) 21.2 22.8 23.1
Growth (%)* 64.0 7.9 1.4
CEPS 29.8 34.1 35.1
DPS (Rs) 2.4 2.0 2.5
ROE (%) 18.0 16.5 15.8
ROCE (%) 19.3 17.7 16.7
EV/Sales (x) 0.3 0.3 0.3
EV/EBITDA (x) 2.3 2.5 2.5
P/E (x) 3.6 3.3 3.3
P/Cash Earnings 2.5 2.2 2.2
P/BV (x) 0.6 0.6 0.5
Source: Company, Kotak Securities - Private
Client Research
RESULT UPDATE
Dipen Shah
dipen.shah@kotak.com
+91 22 6621 6301
Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 3
MORNING INSIGHT November 9, 2009
n Revenues from AIG also continue to remain impacted.
n The AIG business has scaled down and we do not expect any revenues to accrue
in future quarters till AIG re-structures its own business.
n The average realizations were also down marginally QoQ but the revenues were
positively impacted by about 0.7% due to exchange fluctuations.
n The license fees were marginally higher, contributing to 0.13% of the revenue
growth QoQ.
Early signs of stability
n The management has indicated that, there is some stability which it has seen in
select areas, whereas, others remain challenging.
n Also, the development and other discretionary work remains impacted with
little spending by clients on the same. On the other hand, run-the-business jobs
remain un-impacted
n Clients continue to focus more on cutting costs and reducing flab.
n While sales cycles remain long, there are more prospects and leads, which now
need to be converted into business.
New projects received during the quarter
n During the quarter, all businesses including ECnet and Indus, bagged new
projects.
n The company added 10 new clients during the quarter.
n Ecnet and Indus continued to win business with the collections product now
servicing 5 clients in the telecom vertical. In the previous quarter, Indus had
added a client in a new vertical in the form of a private insurance company.
n The iPLM business received orders from a large company in the logistics sector
in Malaysia.
n We remain cautious on the volume growth rate in CY09 and in early CY10 because
of the softness in the global economy.
Margins impacted
n EBIDTA margins were higher by about 260bps on a sequential basis.
n Margins were higher on the back of higher utilization levels and salary adjustments.
The company re-structured salaries leading to reduced. Changes in gratuity
and leave encashment balances due to changes in yields during the quarter
also helped improve margins for the quarter.
Other income rose
R Systems reported a higher other income at Rs.22mn for the quarter. While
Rs.13mn came in from the investments and idle cash, the company also had a forex
gain of about Rs.8mn. This is as against a loss of Rs.13mn in the previous quarter.
Cash balance / DSOs
n R Systems had a net cash balance of about Rs.810mn as at September 09. This
works out to about Rs.66 per share.
n We see the cash in the balance sheet as a cushion against any significant fall in
the price from the current levels.
n The DSOs were at about 61 (excluding unbilled revenues), same as the previous
quarter.
Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 4
MORNING INSIGHT November 9, 2009
Future prospects
n We have incorporated the 3QCY09 results in our CY09 earnings estimates.
n We expect the revenues in CY09 to be about 9% lower YoY at Rs.3.27bn.
n We have assumed the rupee to appreciate to Rs.47 per USD by CY09 end, impacting
revenue growth.
n We expect net profit to de-grow marginally to Rs.279mn with EBIDTA margins
being lower than in CY08. This excludes the one-time provision of Rs.209mn
made in 2QCY09.
n This leads us to an EPS of Rs.22 for CY09, based on the reduced number of
shares post buy-back.
n We also introduce CY10 estimates.
n We expect revenues to be marginally lower on a YoY basis. This is largely due to
the exchange rate. We have assumed the rupee to appreciate to rs.45 per USD
by CY10 end. Volumes are expected to be about 6% higher during the fiscal.
n Margins are expected to remain stable as the cost control initiatives and higher
expected utilization levels set off the impact of rupee appreciation.
n Consequently, PAT is expected to grow marginally to Rs.283mn; an EPS of
Rs.23.
Valuations and recommendation
n The stock is currently quoting at low valuations. The valuations have remained
undemanding because of the consistent macro concerns over the sector, in
terms of deterioration in the user economies.
n The de-growth in revenues of R Systems over the past few quarters have also
raised concerns.
n We have arrived at a price target of Rs.90 based on the DCF analysis, at which
levels our CY10 earnings will be discounted by about 4x. We have assumed a
more challenging demand scenario in the medium term.
n We will become more positive on the stock post seeing increased hiring and
consistent revenue growth on a sequential basis.
n However, the company has cash of Rs.66 per share and this should provide adequate
cushion on the downside, we opine.
Concerns
n Rupee appreciation beyond our assumed levels could provide a downward bias
to our earnings estimates.
n A delayed recovery in major global economies could impact revenue growth of
Indian vendors, including R Systems.
