KPIT - CASE (connected, autonomous, shared, electric) - Focused Automotive Play

Stock Opportunities Untested - but worth a good look
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Gents,

Been on the forum for a few months, but substantively posting for the first time so please do let me know if there is any format/ details that I should put in but Iave missed. I’ve tried to be accurate with the info here but more than happy to be corrected as most info has been taken from news reports, google searches and free broker notes.

I wonder what fellow investors think of KPIT Tech (earlier known as KPIT Cummins). I do own a bit and may be looking to buy more hence look forward to learning what fellow investors think. A brief background of the company follows:

KPIT is an IT services company that provides varied services and products to multiple industries, primarily in USA and Europe. The market capitalisation of the company is about Rs. 3000 crore with FY14 revenue of ~ Rs 2700 crore, Ebitda of Rs 422 crore and PAT of nearly Rs 240 crore (EPS of Rs 13.42). KPIT generates an ROE of 20%, ROCE of 29% and Ebitda margin of 15.7%. The company has grown its revenue and PAT at a 38% Cagr over the last three years. Also, the management has set itself a revenue target of US$1bn for FY17 (Rs6000 crore, at a 20% Ebitda) which translates into a revenue Cagr of over 30% going forward if the target is to be met.

Detailed financials are available at http://www.moneycontrol.com/financials/kpittech/consolidated-profit-loss/KPI02

I am not an IT sector specialist, but it appears to me to not be a run-of-the-mill IT company given that the top management has keen interest in developing the atecha side of the business versus just the business IT side. As per a statement from the CEO in Sept 2013, technology (custom algorithms, own software, development of independent products etc) forms about 33% of the company revenue with the rest being business IT (ERP implementation, portals, website, business applications etc). This mix they want to make 50-50. Also the company doesnat compete in the crowded banking/ insurance space like many other IT cos but concentrates on automotives, manufacturing and energy/ utilities space. Conceptually I like the automotive vertical as intuitively I feel cars and other automotive equipment will have more and more software/ electronics going forward. KPIT is already the largest 3rd party auto electronics vendor in India and so should be a prime beneficiary of this trend.

A key irritant for the stock IMHO has been KPITas relentless acquisitions over the last few years that may have perhaps led to dilution, negative free cash flows and integration issues. But I think that KPIT management is recently through with a restructuring exercise and so perhaps one might see execution capabilities and efficiencies increase. Also, I am unsure if acquisitions can continue indefinitely.

As per a recent MO report on KPITa

http://www.motilaloswal.com/Financial-Services/Research/Detailed-Report/Results-Update-Review/10275/532400

aIts FY15 and FY16 EPS stands at Rs 13.5 and Rs 17.1 respectively. However, I notice that the analyst has factored Ebitda margins of 14.8% and 15.9% for the years, which are virtually at par with 4QFY14 levels. I of course donat claim to understand companies as well as sector specialists, esp IT, but wonder if he/ she has been too conservative in factoring in the managementas restructuring exercise or the profitability of the companies that KPIT has bought since 2003/ 2004. Is there then room for investoras assessment of the companyas fortunes to be jerked upward? KPIT has managed to clock Ebitda margins of 18-20% in the past and this is in-line with their target for FY17 so it isnat completely unreasonable to assume that margins will move closer to 20% in the next two years.

But even assuming that the current estimates are correct, KPIT only trades at 8-9x FY16 earnings. It appears to me all the negatives are factored but valuation leaves no room for any positive surprises. Maybe I am wrong, please do share your views on the company!

PS: Owning KPIT also offers an option on the success of Revolo which seems to me is an exciting possibility: http://en.wikipedia.org/wiki/Revolo

Thanks!

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Nice write up anirudha.

I was invested in KPIT sometime back based only on technicals and tried to read up on

the company and was impressed with the company’s business.

It definitely doesnt seem a run of the mill software company.

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Agree with Hitesh. They are moving into some kind of product development. But I think a better understanding is required on the following:

a) Why did the company undertook so many acquisitions? These have resulted in an inflated consolidated asset base due to goodwill of 599 crores.

b) Trade receivables on a standalone basis are 90 days sales outstanding. Looks higher than most of the industry.

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Valid point wrt acquisitions I think. I mention the acquisitions as one of the impediments to investor interest to the stock in my main writeup.

But, I am not too worried about the acquisitions as all of them appear to be well focused in the areas that KPIT wants to grow in. My best guess is that the management considered buying expertise/ clients advantageous vs. trying to grow the same organically.

E.g. CG Smith was acquired in 2006 for US$6m and that marked KPIT’s true large scale foray into automotive sector. Today Auto contributes over a fourth of KPIT revenues. Similarly, Sparta was acquired in 2009 for their strong presence in USA in the SAP space. SAP is also about 23% of revenues today, USA. as a whole contributes over 70%. Also, CPG solutions bought in 2010 brings in customer base for Oracle in the USA if Im not mistaken. The latest one is i-Cubed…which is a Product Life cycle management company appears to be an instance of KPIT trying to increase the intensity of its client mining esp in the manufacturing and auto space.

So yes, whilst it would have been best if KPIT had acquired the required expertise and/ or clients on its own, the management has taken the acquisition route. Not completely unreasonable considering that the company wants to take the tech route for its growth. Also, from my limited viewpoint, none of the acquisitions appear to be haphazard in terms of the segments they wish to address.

Also, I am perhaps mistaken, but page 125 of KPIT FY14 AR says goodwill is about Rs28 crores not Rs599 crore. Am I looking at the wrong place? (standalone number page 83 is lower at about Rs 8 crore).

To address the debtors question, the debtor days are around 80-82. Actually I didn’t think that a 3.0 month customer payment cycle was significantly slower than normal. But that is probably because of my ignorance. However, one possible reason could be that nearly 33% of the business is tech based, so payments would be on completion of milestones basis rather than a normal ticketing job associated with routine software maintenance, error testing type of jobs. Just one possible explanation.

Thanks for your feedback though allowed me to flesh out some of my own concerns on the stock.

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Look at consolidated numbers page 106

FY14 FY13

Goodwill (on consolidation) 5,994,097,598 4,423,426,343

This is the goodwill, or extra amount paid surplus of book value during acquisition of various companies both by the parent and subsidiary companies. Receivables are on the higher side. If you look at industry Infy is @60 days, TCS @82 days, Persistent @64. It looks higher. What is important is to see how the receivables have changed over time because with a lot of acquisitions you tend to acquire a lot of bad debt (looking at previous ARs can give us this info). Another thing has not mentioned is the period outstanding of various receivables. A breaking up in terms on months could be very helpful.

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Look at their cash flow statement of YE Mar14:

Net Profit before Tax : Rs. 197 cr

But cash generated from Operations is only Rs. 68 cr

The gap of around Rs. 120-130 cr is the increase in Debtors from 222 cr to 356 cr.

So its important to ascertain how much of this is really recoverable, otherwise the profit is only on paper.

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Good points on the debtors bit. Page 126 breaks debtors into over 6 months and under six months. Also, further into good and doubtful. Over six months debtors are 6% of the total and virtually the full amount has been provided for.

Receivables appear to be in-line with TCS (82 days) though higher than some others, but that may be because of the milestone billing. Again, Im only guessing here.

Agree with the contention that quite possible that debtor increase has happened due to acquisition but that remains to be tested based on recoverability in the coming months. Has anyone heard any earnings call with KPIT? (I havent). Do the management talk of debtor recoverability there? or even the break between op cash flow and pat?

Do you think I can simply write to the company and check if they reply?

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Anirudha, if you are a shareholder, the company is bound to reply to your query. If you are not, they may not bother.

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Timely thread for me :slight_smile: THanks, I added some KPIT today as it featured Forbes best under a billion and its not expensive i have been reading about it so far it seems okay. The only problem is promotor holding is low very low any insights into it?

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Actually Mukul, I would love to hear your thoughts. Some others have raised a few valid questions on the company. Maybe you can share your +ve and -ve thoughts on the same?

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i am still reading about it it will take some time to know more about it and say something meaningful may be you guys are better judges .I listened to the last confernce call and frankly i wasnt very impressed, I am wondering how they got in the forbes list, it was due to the tone of management on call. They have guided for higher growth and margin for the rest of the year so that should be positive and we can see how it goes. The best part is stock isnt expensive so if they deliver any growth the stock price should follow. The point raised by Bomi is also very valid point, I think unless they are dealing with the govt (or some entity which pays late), it looks more like paper profits. Also this is slightly superficial let me dig deeper slowly

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I compared the numbers (about sundry debtors) with other IT companies, it doesnt look like fraud, its normal for IT companies to have sundry debtors as their client pay them after sometime. its a little higher in KPIT as their DSO is higher but it doesnt indicate fraud.

Any idea why they have debt, Normally IT companies dont have any debt and loads of cash, Any clues why they raised debt?

Thanks

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I dont think its a fraud either, but in my limited opinion more a function management attention been diverted to acquisitions and integration more than getting down to to grime of running a business day to day. Again, this is just a guess on my part.

However, the company needs to bridge the enormous gap between reported PAT and the operating cash flow. An IT company that professes its IP and tech edge should not have to depend upon credit period for attracting/ retaining clients like a low tech B&M company, if at all this is happening.

Also, if they simply paid the debt using the cash they have OR increased dividend payout it would increase the confidence I have in that cash number being reported.

Thirdly, some sort of a moratorium in acquisitions to build on organic growth would be preferable.

Having said this, I think the 8-9x multiple appears to have factored all this in IMHO. Lets see how this pans out.

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Highlights of the Call by Capital Mkt:

In INR terms, The Revenues grew by 9.82% QoQ (7.78% YoY) to Rs 757.41 crore for the quarter ended September 2014 and Net profit grew by 39% QoQ to Rs 70.55 crore for the same period.In USD terms, the revenue grew by 8.5% QoQ (11.37% YoY) to USD 125 Million for the quarter ended September 2014.

The APAC grew by sharp 42.64% QoQ, while US grew by 4.35% QoQ during the quarter. However, there was a decline of 5.89% QoQ in Europe for the same period. Amongst the SBUs, A&E SBU grew by 24% QoQ followed by SAP 8.69% QoQ and IES 2% QoQ respectively. However, BTU declined by 5.26% QoQ during the quarter.The high growth in APAC geography and A&E SBU was largely contributed by ramp up in telematics deal. It also registered a significant IP based wins in APAC during the quarter in A&E SBU.

The EBITDA margins improved from 12.06% in last quarter to 13.34% during the quarter. It continues to improve the margins in SAP SBU. The SAP SBU margins stood at mid-single digit level and target to exit the year at double digit margin. It believes that it is on track to achieve this. The telematics deal had a good ramp up during the quarter.

The realized rate for the quarter was Rs 60.59/ USD against Rs 59.87/ USD in last quarter. This helped improve EBITDA margins by around 30 bps. It is also able to grow offshore business which resulted in improvement in overall EBITDA Margins.It has signed a customer transfer agreement with one of Japanese partners during the quarter. It is working with these customers earlier through the partner.

The largest customer Cummins grew by 1.93% QoQ with revenue share at 14.9% while the Top 5 and Top 10 customers grew by 1.25% QoQ and 3.03% QoQ respectively.There has been good pipeline build-up in E-Business Suite (EBS) and JDE practice with respect to new deals and closures during the quarter. It also won a few deals for Value Chain Execution (VCE) offering.The major areas of traction for SAP SBU continue to be SuccessFactors and HANA. During the quarter, it won multiple deals in focused vertical manufacturing, for implementation and also AMS. Amongst geographies it won deals across US, APAC and META regions.

During the quarter, it filed 5 patents in automotive domain. These also include provisional patents for which complete specifications are yet to be filed.It submitted REVOLO fitted vehicle as per the requirement of AIS-123, notified under BIS Act, 1986 and hope to receive the certification shortly. The progress outside India on REVOLO is progressing satisfactory. It remains positive on the prospects for REVOLO.

The effective tax rate was lower during the quarter. It filed for revised tax returns and as a result, was in a position to lower the required tax provisions. The revised tax returns were filed in the US jurisdiction after completion of extensive revised documentation.It expects the tax rate to by 29% for the FY15, minus the tax credit taken in this quarter.

The H1 profit number and the profit estimates for the remainder of the year, it believes that it will fall short of the annual profit number as guided at the beginning of the year by approximately 10%. It believes there are 3 major reasons for the shortfall in the profit guidance number viz. Hiring of senior level industry experts has been more and faster than the anticipated number at the start of the year, the pace of growth in our non-linear revenues got slightly delayed by a quarter as reflected in the Q1 growth which had a cascading effect and the actual forex gains have been lower than earlier anticipated and in Q1 the growth in both revenue and thus resultant profitability was lower which had a cascading effect for the whole year.It remains positive on growth prospects for second half of the year.It aims to reach the annual revenue of USD 500 Million in FY15.

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Massive correction in Price and this gem is available at less than 8 PE. Any takers ?
Note: Not tracking but recently came into my radar

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This is not a forum for buy/sell recommendation. You need to go through the discussion of the stock and take your own call. Asking such questions is not appropriate.

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  1. I feel the underlying business is witnessing temperory stress owing to slowdown in O&G market, select segments (SAP) and headcount growth ahead of revenue. All could normalize in 3-4 qtrs.

  2. The bigger concern and worry is the business has not produced FCF and is taking money from debt and equity markets consistently. Not the sign of an IT services firm. This red flag on use of cash by promoters is the discount that can go away with time (markets forget).

Likely 1) and 2) will happen together.

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KPIT has had +ve Operating cash flow at least for last 5 years. What they have not had is Free cash flow every single year, though this is present in 2015. The business does seem throwing off lot of cash.

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Disc: Invested in recent low since my belief is that the negatives are already (more than) factored in.

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Hi arunsag…Past cashflow doesn’t matter when the current (and possibly future) business environment is changing. remember WB quote “Today’s investor doesn’t benefit from yesterday’s growth”

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