Results Update Satyam Computer Services

(BSE: 500376 | NSE: SATYAMCOMP | ISIN: INE275A01028)

1QFY08 above estimates, forex losses dampen profits: Satyam Computers reported dollar revenue growth of 9.2% to US$449m in 1QFY08, higher than our estimate of US$441m. This was driven by volume growth of 8.1% QoQ and increase of 1.1% in blended pricing. EBITDA margins declined 65bp due to rupee appreciation and visa costs. Net profit declined 3.9% to Rs3.78b due to lower other income of Rs632m, which was impacted by forex losses of Rs65m.

Estimated 125bp margin erosion results in rupee EPS guidance downgrade in FY08: Satyam has upgraded its dollar revenue growth guidance to 34-35.5% in FY08 from 28-30%, and the dollar EPS guidance marginally upward to 28.3-29.7% from 27-29%. Corresponding rupee revenue guidance has been revised upward to 21.1- 22.5% from 20-22%, at underlying rupee assumption of 4.5 v/s 42.3 earlier. However, the rupee EPS guidance has beendowngraded significantly to 12.5-14% from 18-20% earlier. The new EPS guidance of Rs24.14-24.46 factors inmargin erosion of 125bp v/s assumptions of flat margins earlier.

Cutting FY08 EPS by 5%; Maintain Buy: We continue to be impressed with Satyam’s execution in terms of reduction in attrition rates and diversification into other service offerings such as engineering services and infrastructure management, which will improve earnings visibility going forward. However, we have cut our EPS estimates for FY08 and FY09 by 5% and 2% respectively to Rs25 and Rs30.7 to reflect higher rupee appreciation. On revised estimates, the stock trades at 19.1x FY08E and 15.6x FY09E. Maintain Buy .1QFY08 above est., forex losses dampen profits

Satyam Computers reported dollar revenue growth of 9.2% to US$449m in 1QFY08, higher than our estimate ofUS$441m. This was driven by volume growth of 8.1% QoQ v/s estimate of 6% QoQ and strong growth across theenterprise and consulting businesses (up 13.3%QoQ). Price realization improved 1.3% onsite and 1.5% offshore v/sestimate of 0.6% onsite and 1% offshore, boosted by higher pricing in the enterprise business. Rupee impacted margins by 230bp during the quarter, while visa costs had a 100bp impact. EBITDA margin decline was contained at 65bp (v/s estimate of 100bp) by higher price realizations (110bp) and higher utilization rates (76.5% v/s 71.3% in 4QFY07). Other income at Rs632m was lower than estimate of Rs912m due forex losses of Rs65m (forex gains of Rs900m against translation loss of Rs965m). Net profit declined 3.9% to Rs3.78b v/s our estimate of flat profits due to lower other income during the quarter.HR metrics continued to improve during the quarter; attrition rate (a concern earlier) has also declined to 14.9% in 1QFY08 from 15.7% in 4QFY07 and 19.6% in 1QFY07 even as exposure from the enterprise business increased to 44.2% in 1QFY08 from 42.6% in 4QFY07 and 40.3% in 1QFY07.

Estimated 125bp margin erosion results in rupee EPS guidance downgrade in FY08

Satyam has upgraded its dollar revenue growth guidance to 34-35.5% from 28-30% in FY08, and the dollar EPS
guidance marginally upwards to 28.3-29.7% from 27-29%. Corresponding rupee revenue guidance has been revised upward to 21.1-22.5% from 20-22%, at the underlying rupee assumption of 4.5 v/s 42.3 earlier. However, the rupee EPS
guidance has been downgraded significantly to 12.5-14% from 18-20% earlier.

In our last update, we had modeled a 100bp decline in FY08

margins in the view that management’s earlier guidance of flat margins was optimistic due to inadequate margin levers that would offset margin pressure. The new EPS guidance of Rs24.14-Rs24.46 factors in margin erosion of 125bp v/s assumptions of flat margins earlier. This is in addition to wage hikes to the extent of 5% onsite and 16% offshore, which are expected to impact margins by 325-350bp in FY08. We believe that higher revenue from the enterprise business (where cost pressures are higher) has contributed to lower margin guidance, in addition to higher rupee appreciation and salary hikes. Our current estimates factor in margin decline of 170bp in FY08.

Downgrading FY08 EPS by 5%; Maintain Buy

We continue to be impressed with Satyam’s execution in terms of reduction in attrition rates and diversification into other service offerings such as engineering services and infrastructure management, which will improve earnings visibility going forward. However, we have reduced our EPS estimates for FY 0 8 and FY09 by 5% and 2% respectively to Rs25 and Rs30.5 to reflect higher rupee appreciation. On revised estimates, the stock trades at 19.1x FY08E and 15.6x FY09E. Maintain Buy .

Satyam Computer: an investment profile

Company description Satyam is the fourth largest Indian IT services company employing more than 38,000 people. It enjoys leadership position in the package implementation services segment and services over 550 clients including Fortune 500 clients. It services top companies in every industry including GE, Ford, Merrill, DuPont, Cigna and Applied Materials.

Key investment arguments

  • One of the largest beneficiaries of global clients’ current preference for offshore vendors.
  • Leadership in the enterprise applications space would help Satyam tap the strong demand environment.

Key investment risks

  • Frequent comparison with peers on qualitative aspects leads to dissatisfaction.
  • Lacks innovation in managing cyclical trends in comparison with peers.
  • Expectations are high due to comparison with peers
  • Recent developments
  • Awarded a US$200m contract for managed services by Applied Materials Inc.
  • Ranked the ‘3rd Best Company To Work For In India’ by BT-Mercer-TNS, for Human Resources practices, and commitment to Associate Delight.

Valuation and view

  • CAGR of 27.4% in sales and 21.1% in net profit over the next two years.
  • Valuations at 19.1x FY08E and 15.6xFY0E offer room for upside
  • Maintain Buy with a target price of Rs550, upside of 15.1%

Sector view

  • Various CIO surveys indicate increasing share of offshore spending in IT budgets.
  • Sharp rupee appreciation continues to be a cause for concern over the near term.
  • Prefer large companies as they win the bulk of volumes while niche players benefit due to lack of competition.

Investment in equity shares has its own risks. Sincere efforts have been made to present the right investment perspective.The information contained herein is based on analysis and up on sources that we consider reliable. I, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and I am not responsible for any loss incurred based upon it.& take no responsibility whatsoever for any financial profits or loss which may arise from the recommendations given in this blog.

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