KPIT Cummins

Investors with a one-two year perspective can consider buying the shares of KPIT Cummins Infosystems, given its reasonable business prospects and valuation.

At the current market price (Rs 103), the stock trades at 14 times its estimated 2007-08 earnings. This estimate takes into account the 12-15 per cent price increase on new contracts to be effected from January 1 next year, but conservatively assumes that the company may not meet its guidance this year.

At this valuation, KPIT trades at a discount to Tier-2 players such as Hexaware, iGate and MindTree. If the company achieves its guidance, the valuation would be more attractive. Apprehension on revenue and margin pressures arising from the rupee appreciation, the sub-prime crisis and the possibility of a US slowdown tend to affect Tier-2 companies significantly because of their considerable dependence on the US and BFSI (banking, financial services and insurance) verticals.

But it is here that a player like KPIT can be a reasonable bet. KPIT Cummins has a differently focussed business model compared to other Tier-2 players and derives less than nine per cent of its revenues from the BFSI segment.

The company derives over three-fourths of its revenues from manufacturing, auto electronics, and semiconductor solutions clientele. Business Intelligence solutions is another key area for KPIT. KPIT has hedged $36.8 million, about 25 per cent of its revenues, at Rs 42.6 to the dollar.

Business Drivers

New engagements: Increasingly, KPIT is focussing on bagging multi-million, multi-year deals rather than smaller engagements. This has some healthy facets to it. Most of these engagements are from OEMs in the automotive, semiconductor and manufacturing sectors as well as others.

New deals and existing engagements are increasingly coming in from the Asia-Pacific and European clients, thus expanding the company’s geographical footprint. The manufacturing and automotive sectors are seeing robust growth in both these regions, especially in the Asia-Pacific region.

Auto electronics may play a key role in fulfilling the rising safety requirements and increasing sophistication in car manufacturing.

In this context, KPIT’s engagements with car OEMs and suppliers offers possibilities to enlarge the existing business and bag new contracts. This may also help KPIT decrease its dependence on the US from the present 56 per cent, thus reducing currency risks.

Expertise and business partnerships: Business Intelligence solutions is an area that has contributed increasingly to revenues. Being a high-margin service, it is good for realisations. This works through (implementation) partnership with leading players in this space such as Business Objects.

This vertical has also helped the company cross-sell services and achieve better client-mining. KPIT also has a partnership for implementing enterprise software with players such as SAP and Oracle. Many of the multi-million dollar deals are coming in because of such partnerships.

The company has also formed a JV with Symbio, in China, which may help serve global customers with Chinese presence.

Operating metrics: The onshore-offsite mix is seeing an increase in the offshore component. Onsite revenues carry high costs compared to offshore revenues and, hence, this mix change may be healthy for the company’s margin. Fixed-price billing, as a percentage of total revenues, is increasing slowly.

This would enable the company in better resource planning and deployment as well as its hedging strategies. Repeat business at 90 per cent appears healthy, indicating better execution capabilities. Employee utilisation in offshore locations, is at a reasonable 70.5 per cent and the company has indicated that it would further increase this to enable better volume growth.
Risks

KPIT Cummins does carry some client-concentration risk as the top 10 customers account for over 72 per cent of revenues. Attrition at a high 21 per cent also creates execution risks.

These apart, KPIT is working in areas such as semiconductors and auto-electronics that require the company to be on top of the game in terms of adaptability to keep pace with the rapidly evolving technologies and changing customer requirements. This may pose quality and technology challenges. Any significant slowdown in the US may also pose client side risks.