Excellent result by the company. One good thing about the Q1FY15 results is the growth in topline which has surprised everyone. Also, the company has announced board meeting for payment of dividend which I think should be more than 5 paid by them in Q1FY14.
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@Dhanwil/Hitesh: Congrats on the wonderful call, and thanks for the detailed report. I also read the Emkay Research report here.
I am struggling with how to model the operating leverage here. In the report it projects 20% top-line along with 20% bottom-line growth for the next 3 years. Let’s say the top-line picture does hold true - Aren’t we to expect better bottom line growth numbers?
Wondering if one of you guys might be able to step in and offer projections in case the thesis of 20% top-line growth plays out…
Thanks,
-Prasanna
Prasanna,
the emkay report provides net profit margins as well in their projections. You can use these for working up projections for next 2-3 years.
Personally I havent yet figured out what sustainable net profit margin will be. I think I would watch for a couple of quarters more to see how things go and then take a call.
The report assumes EBITA margins to stabilize from here-on for the next 3 years and is projecting <20% PAT growth for FY15. Assuming the report holds true and MPS trades at a TTM PE of 20, in March 2015, at 47 Cr NP as they are projecting, implies upside of 15% or so from current levels - which is probably not much.
Are you expecting much more than that?
The report also expected the operating leverage to play out only till FY14 and stabilize, implying a 20% growth in revenue leading to almost identical bottom-line growth… Which is not what you guys are expecting going forward right? Which is why, I wanted to understand your model (if it’s different from EmKay), in-terms of fixed vs variable costs, and how to project the bottom line.
Thanks,
-Prasanna
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Hi Prasanna,
Frankly speaking I am not very good at projecting numbers at least in short term hence I do not have specific answer to your question. In my opinion, it will be difficult to predict operating leverage in pure numbers term both in short term and long term. However, in my opinion following are key drivers of operating leverage for MPS
-
increased productivity of the employees (revenue/employee is a key yard stick) - MPS has been successfully doing this, first stagnating and then rationalizing the head count. Moving forward, the operating leverage can kick in if the same people can do more “value additive” work by moving up the value chain. We need to monitor this parameter closely as the same thing seems to be playing out. However, I would like to wait for the full year numbers to validate this assumption before reaching any definite conclusion.
-
Second lever for operating leverage will come when substantial portion of revenue will be driven from digicore platform as solution/application rather than from outsourcing of activities on publishing work flow. Though, in my opinion, we are still 4-5 years away (as mentioned by the management in last con call) from this level. It may change the business dynamics all together.
So, in the wake of current context, it is better to assume 31-32% EBIDTA level to work out the numbers and then adjust it, if the actual numbers change significantly over next 3 quarters.
As to the valuations, it has run up a lot since results, and it is not cheap by any means! So, the downside protection that one had, has diminished at current level. Now, the stock performance can move either way depending upon how well the company performs with respect to market expectation (which has priced in 20-25% top line growth with 30% kind of EBIDTA margin).
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The company has declared an interim dividend of Rs.12 per share for Q1FY15 which has increased from Rs.5 paid by them in Q1FY14. Last year they paid total dividend of Rs.17 per share. Conservatively, I think the full year dividend should increase to Rs.25 per share (optimistically around Rs.30 per share). I think that is the best part of management. Their business model is not capital intensive until and unless they go for acquisition and hence they return most of the profits to shareholders in the form of dividend.
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The declaration of Rs 12 per share dividend sends a strong message from the management about the earnings in next few quarters as well as the asset light nature of the business.
I too feel that expectations of a total dividend of Rs 25 per share for fy 15 may not be totally misplaced. If that happens, that could set a floor to stock price around 480-500.
If company can show good growth there could be very high chances of substantial re rating, once a strong conviction builds in market participants about the sustainability of growth.
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As per the Q1FY15 concall, the management seems confident of growth in the near to medium term with vendor consolidation happening at customer’s end as well as more outsourcing being done by them. The focus of management on volume growth with some hit being taken on pricing in FY14 and earlier years seems to have played out in Q1. Also, the opportunity presented post acquisition of Element seems to be big. I am very impressed by the confidence exhibited by Nishith Arora, Chairman and MD.
Some salient points from the concall
Currently the company offers only a few services from the whole bouquet of services to different customers. e.g it offers 3-4 services to a particular client or 2-3 services to another client. Company can see huge scope to expand the number of services they offer to their existing clients. deeper mining of clients could lead to much higher revenues.
Company doesnt want to carry cash more than necessary. (I would interpret it as a continuation of high dividend payouts)
A suggestion to put up audio transcript of questions asked in AGM was accepted.
Dehradun facility has (? 687) employees against total capacity of 2000.
Company wants to have higher volume growth with clients even if that means taking some small cuts in margins. Company wants to become important for their clients.
There was mention of some shareholders at agm who came from rajasthan who provided the management with some painting and who came up with the opportunity size by providing details of their clients’ revenues. the shareholders provided details of revenues of elsevier and other clients of theirs.
Management seemed to indicate that they are at an early stage of their journey.
ADI had BPO operations at Dehradun but after taking over MPS it was phased out and 50 employees from those operations were shifted to MPS. NIshith Arora is fully involved with MPS only. He doesnt have any other focus area including even ADI. (actually ADI remains a sort of promoter kind of holding company)
Growth impetus has come mainly from school education business and books business.
Cost rationalization is an ongoing practice and would continue.
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Hiteshbhai has covered most of the key points discussed in the call. Few more to add to the same
- In terms of EBIDTA margin peaking and further room for improvement in EBIDTA from 30% level, management mentioned that across industry there is large variation in margins with some companies making operating losses while some making much higher margin than MPS. Mr. Arora cited an example of one of the competitors in the same segment focus (STM) having 100 Crore + top line size making EBIDTA margin of 50%! Hence management clearly indicated, that there is a possibility to improve margins.
- According to management, the key differentiator on why one of the competitor is able to generate such high margin is the productivity! Mr. Arora categorically mentioned that higher margins are not result of better pricing as both MPS and the competitor compete for the same deal and price points are similar. Higher productivity is the key to margin improvement.
- According to management, the competitive landscape is changing as consolidation is seen to be happening in last few years and management is of the opinion the the same trend is likely to continue with MPS being on the right side of it. MPS is one of the top-3 vendors across the world in the STM segment.
- As a value investor, what I liked most was management’s strong will to do acquisition only when they get the right opportunity at right price. The whole approach towards acquisition is conservative as Mr. Arora mentioned that majority of acquisition fail to deliver value because of over paying or it is strategically mis-fit.
- He also alluded that MPS has got a major win from a large client but did not provide the details as the final agreement is yet to be signed.
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Few points to note with regards to MPS :
(1) When MPS got acquired by Adi (Mr. Nishith Arora) in Q2FY12, post that there was lot of rationalisation of business as also significant discountsbeing offered on existing contracts by the new management as many of the exisitng clients were unwilling to stay without 'Macmillan' brand at pre-negotiated rates.This is the reason why we saw significant constant currency decline in revenues till FY13. However, currency helped the company alot during that period because of which it was able to post YoY revenue growth in INR terms in that period. The trend reversed from Q4FY13 post which we saw positive growth (although lumpy) in constant currency terms. Below is the table depicting YoY USD growth and INR growth for the company post acquisition.
|
Q1FY15 |
Q4FY14 |
Q3FY14 |
Q2FY14 |
Q1FY14 |
Q4FY13 |
Q3FY13 |
Q2FY13 |
Q1FY13 |
Q4FY12 |
Q3FY12 |
|
|
Revenue (in $ mn.) |
7.5 |
7.5 |
8.7 |
7.6 |
7.1 |
7.4 |
8.0 |
7.5 |
7.1 |
7.2 |
8.5 |
|
YoY Gr. ($ terms) |
+ 5.63 % |
+ 1.35 % |
+ 8.75 % |
+ 1.33 % |
0 % |
+ 2.77 % |
-(5.88) % |
-(12.79) % |
-(14.45) % |
-(2.70) % |
-(4.49) % |
|
YoY Gr. (INR terms) |
+ 13.64 % |
+16.29 % |
+24.43 % |
+14.35 % |
+2.94 % |
+ 9.86 % |
- (0.52) % |
+ 5.13 % |
+2.87 % |
+ 9.06 % |
+8.28 % |
(2) Management did an excellent jobon cost rationalisation front, particularly Employee expenses and Other expenseswhich can be seen from the following table :
|
Q1FY15 |
Q4FY14 |
Q3FY14 |
Q2FY14 |
Q1FY14 |
Q4FY13 |
Q3FY13 |
Q2FY13 |
Q1FY13 |
Q4FY12 |
Q3FY12 |
|
|
Employee as % of Sales |
47.16 % |
41.20 % |
36.02 % |
39.18 % |
52.04 % |
44.51 % |
44.62 % |
47.54 % |
52.03 % |
46.11 % |
53.11 % |
|
Other Expenses as % of Sales |
21.82 % |
19.25 % |
18.89 % |
24.97 % |
25.43 % |
26.17 % |
24.75 % |
26.04 % |
28.74 % |
37.58 % |
27.59 % |
|
EBITDA Margin |
32.66 % |
38.44 % |
42.50 % |
37.27 % |
23.04 % |
29.68 % |
28.57 % |
26.83 % |
19.09 % |
12.87 % |
7.32 % |
(3) Management also did an excellent job in investor communication by remaining proactive in every aspect as also heeding to every good suggestion of analysts/investor community. I must say that there arehardly anycompanies of MPS size on Indian bourses that are so much investor-friendly.
(4) Talking of the industry, industry size itself is growing at a very slow pace and the pace is unlikely to fasten up even in years to come. This is the reason why there are limited number of large players in the segment and small players which are there have found their niche of operation. What is likely to happen is consolidation amongst industry players wherein large players will compete for a larger share of the pie.
(5) Pricing power is completely absent and I am glad that management candidly admits it. In case of sharp currency appreciation (which is unlikely over medium term), this could be a real trouble and it could bring down margins very sharply.
(6) Vendor criticality is also absentin favour ofMPSwith most of the large clients of MPS. In one of the concalls, management said that 'if MPS had to shutdown most of the publishers will shutdown', this might be true for 35-40 small clientsfor which MPS works for but not true for clients that must be accounting for more than 50 % of company's revenues.
(7) It is noteworthy to have a look at the acquisition price paid by the acquirer for Aptara (MPS peer)in early 2012. At that time, Aptara was more than 2 times the size of MPS in all aspects, be it revenue, employee size, etc. and had 5 times more customers than MPS.
|
TTM Revenue |
TTM EBITDA Margin |
No. of Employees |
No. of Customers |
Acquired @EV/Sales |
Acquired @EV/EBITDA |
|
INR 371 cr. |
18.30 % |
5,000 |
300 |
1.77 |
9.66 |
(8) If we take CMP of 570 and check the statistics, it comes to :
|
TTM Revenue |
TTM EBITDA Margin |
No. of Employees |
No. of Customers |
Trading @EV/Sales |
Trading @EV/EBITDA |
|
INR 197.28 cr. |
33.53 % |
2,737 |
70 |
4.85 |
14.49 |
(9) Here, we also need totake note (if we wish to) of thecurrent value of real estate assets owned by the company which should come to ~80-100 cr. out of which a property worth~30 cr. in Bangalore management is willing to encash in case company finds a suitable buyer. All other real estate assets are currently in use by the company and its highly unlikely that company will disturb its existing set-up by moving out of current locations to encash on property value.
(10) The entire investment case for MPS revolves around three things -- Cost Cutting, Rich Dividends and Asset Base.
(11) Cost cutting and therefore high EBITDA margins are the real forte of the new management. Even loss-making Element which was acquired last year by the company has turned around and registered EBITDA margins of ~40 % in Q1FY15. Thats a great achievement and in case company can acquire a large size company (50-80 cr.) at 1 times or less than 1 times sales (w/o large debt) and bring it to 35-40 % margins then it will add a significant incremental value to company's financials. management has gone on record to state that it has previously worked at 55 % EBITDA, however, at that time scale must have been small. Also, in recent concall management stated that there is one peer in STM space which works on 50 % EBITDA margins, however, as investors we need to look at majority and it seems companies of larger scale (like Aptara) are working on lower EBITDA margins and even management says that many are making losses or working on thin margins. On long term basis, in absence of currency appreciation/depreciation, we can assume a 35-40 % EBITDA margin range for MPS on sustainable basis looking at management's history.
(12) Company has a stated timeline of 3 years (2017) for platformization...Now thiscould bethe real gamechanger. In case company can spend this 3 years with say 10-15 % YoY USD growth while maintaing 35-40 % EBITDA margins then what will happen is it will have required cash generation to support platform-based approach which could take its EBITDA margins to even 50 % from the fifth year in case its platformization strategy is succesful and it will have a annuity type of model which will be relatively more stable with high stickiness involved than current one. However, all these is slight away and no one knows what will happen in between this 3-5 years period.
(13) Company has adopted a good strategy of paying maximum dividends thereby keeping minimal cash in the company. With this strategy, what the company is aiming for (and thats what I feel) is to trade at richer multiples on a consistent basis and therefore when a mid- or large-size acquisition opportunity comes, dilute promoters' stake in the company by placing equity with PE or FIIs. This is asound approach but, with Aptara going at half the price despite it having double the revenues andemployee base as also 4 times the customer base, PE players are unlikely to get interested in the proposal unless there is some great milestone involved which we are not aware of. However, the equity can definitely be used as currency for acquisition with acquired company's management getting shares of MPS.
(14) Company is looking at focussing on mining existing relationships which is evident from no key sales personnel appointments involved. Company has some good long standing personnel, particularly on technology side because of Macmillan which have stayed on under the new management. Mr. Nishith Arora has placed his son and daughter-in-law in US to extend and handle current business relationships which is good.
(15) There seems to be hardly any issue involved wrt. corporate governance and the new management seems to score excellently on that front. Mr. Nishith seems to be having a great hold on the company's affairs which was eveident from his handling of chaos at recent AGM as also immediately putting up audio of AGm proceedings on its website post concall suggestion. Also, I heard all the concalls and he doesn't seem to be giving any unfair rosy picture of company's operations. Although future guidance is not given which can be taken in either of the way, but, with current state of operations, it is reasonable on the part of management to not talk rahter than talk and not achieve. As he has rightly said, this is just the beginning and at this stage when you don't have long term contracts inplace and customers bargaining every now and then to reduce prices, you don't know how exactly the future will look like.
(16) Dehradun is at the core of entire story of MPS as it is this facility which is making this company achieve such high margins. In case of significant increase in minimum wages at the state the entire business model could be at risk. It will be in the best interest of the company as also its shareholders that company over time (with increase in scale), diversifies into atleast one another low-price location.
(17) For the current valuations to sustain as also enhance, next two quarters will be crucial, particularly Q3Fy15 as it will be on a higher base (USD). We need to look at constant currency growth to assess the situation in next two quarters. Performance till now doesn't warrant this valuation, its the clean management behaviour and shareholder-friendliness that is rewarded for by the bourses and ultimately business needs to catch up fast which I am sure will be.
Rgds.
Discl. - Invested
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Mr Mahesh,
Great analysis. Just one correction the EBIDTA margins for Q1 2015 were around 39 percent. You have incorrectly mentioned it as 34 percent
Hi Sorry you have mentioned it as 32.66 percent.
Hi Hrishikesh,
Pure EBITDA margins without forex gain/loss for Q1FY15 on a standalone basis (for YoY comparison) is 32.66 % only (on a consolidated basis its 33.43 %, however, since past data is w/o element, its better to compare standalone and simultaneously monitor Element operations)…
what you are doing is including forex gain in your calculation…while calculating EBITDA margins from core operations, it is better to exclude forex gain/loss from the calculation so that we can get true picture of the operations. Simiilarly, while calculating PAT margins, it is better to exclude one time 7.72 cr. exceptional gain from the calculation and deduct 34.6 % from 19.07 cr. PBT and arrive at PAT.
Feel free to get back in case of any further query.
Rgds.
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Mahesh,
Absolutely agree with excluding one off depreciation item from PAT margin. But I think it is not fair to exclude forex gains or losses. This is because there will be profits or losses depends upon how the rupee moves up or down and the hedging gains or losses. We should focus on the average realization rate post the forex gains or losses which is a real measure of the actual rupee cash inflows.
So even better way to analyze this is to focus not just on EBIDTA but on the cash earnings (preferably post incremental working capital and incremental fixed assets). This is the concept of owners funds as propagated by Warren Buffett.
So as he mentioned typically MPS is earning around 50 crores per year in cash inflows. Post incremental capex of around 5 crores , we have 45 crores that can be distributed to shareholders. So that translates to around Rs. 30 per share. So assuming a discounting rate of 10 percent, on a no growth basis the per share valuation should be minimum Rs. 300.
But the fuel behind the mps rocket is that it is growing at 25 percent now and more importantly it is doing so without spending any incremental capex (or working capital). So all the increase directly flows to the shareholders. This is unlike many manufacturing units which would have to reinvest continuously in fixed assets to maintain a 25 percent growth rate. It could have been reinvested or as is what MPS is following is distributed to shareholders.
So assuming that mps holds 25 crores as a contingency fund they have enough cash to have a Rs. 25 per share dividend this year.
In case they want to make a big acquisition it will be through QIP/ PE / or M and A route. So the increase in market value will be of great help in getting a favourable valuation for an acquisition scenario.
Will not be surprised if we see a price of Rs. 800 - Rs. 1000 by end of this financial year.
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Hi Hrishikesh,
If our aim is to measure EBITDA from core operations ofthe company, forex gain/loss can not be a part of it as those transactions are meant for hedging the currency risk and are beyond the control of the management. If you include them in your calculations, it will never give you a true picture of the business. For example, say if the currency would not have been favourable in Q1 and if there was a forex loss of say 10 cr. in Q1 itself, so does it mean that company’s core operations have generated an EBITDA of just 10.5 % !!! Such assessment would never provide a true picture…However, there can be two views to this and I respect that.
Similarly, while measuring business growth wherein almost entire revenue is coming from international operations, it is best to measure it in constant currency terms, so when the base effect of currency is stable or not favourable, you can properly assess the real business growth/degrowth and are not in for a surprise on either side. On that count if you calculate YoY growth for FY13 (taking base l-t-l Q1-Q4 of FY12 and not reported 15 months financials) and FY14 then in FY13 actually company’s revenues have degrown by (8.23) % over FY12 and have grown by just 3.3 % in FY14 (still 5.2 % down from FY12 levels). So, 15 % YoY growth (standalone) that you see in FY14 is because of favourable currency and not the real business growth and actually company is still 5 % down from FY12 revenue levels when it was acquired.
Cash generation will be a measure of business growth that the company can achieve over next few years as cost-cutting will have its own limitations. Company has successfully reversed negative growth in FY14 (in constant currency terms) thats a good sign and we can give benefit of doubt to the management on this count as this was only second full year of operations under the new management. However, pricing pressures that management has talked about in concalls, that I can’t find in many of the comparable peers’ financials (available till FY13) as they were able to grow decently over last few years. For ex., a company which Mr. Arora talked about in last concall of operating at 50 % margins, has grown 30 % in FY13 (with 24 % in volume terms) and 23 % in FY12 (19 % in volume terms). Similarly another comparable peer, has grown 22 % in FY13 and 21 % in FY12. Most of this growth of peers seems to be purely organic which in other words means that MPS seems to have actually lost marketshare over FY12 and FY13 because of which these peers which were much smaller in size compared to MPS in FY11 are now similar in size as MPS.
Having said this, it was for this reason only that MPS was sold in FY12 and now is the time for performance to reflect. We can take solace from the fact that its good comparable peers have shown healthy growth and are operating at similar margins (although average margins of all comparable peers on a sustained basis seems to be in the range of 25 % +) and we can hope the same to happen with MPS. MPS is a great story because not many formidable players are presnet in the space because of its limited market size. MPS might be only the fourth or fifth biggest player in the space which means we are investing in a leader. Also, there are not many businesses available today which operate at 35 % + EBITDA margins. However, next two quarters and particularly FY15 will be crucial as core business has to show atleast 10 % constant currency growth with 40 % EBITDA margins.
Rgds.
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Mahesh
I plan to speak to an industry expert in this week. Could you tell me the names of the competitors that you referenced ?
As an aside, companies in this space are hurix, new gen which have been funded by private equity players. Any insights from any of the VP -ers on these companies or access to the management in these companies would be most welcome ?
ofthe
Mahesh,
Let me explain why I include forex gains or losses in EBIDTA calculations specific to MPS.
Suppose Q1 last year the average forex rate (USD/RE) was Rs. 58 and the company had locked in to a rate of Rs. 60. If e.g. the rupee depreciated significantly to Rs. 65 there would be a gain in revenues but that would be offset by a hedging loss so that the net effect would be a realization rate of Rs. 60 only.
Conversely suppose in Q1 for this year the average rate is 60 and again the company has locked in a rate of say 61 and the rupee goes to 55. The loss of reveunues would be compensated by a hedging profit and the net would a realizaion of Rs. 61
So on a constant dollar revunue basis if we exclude hedging profits there would be a huge varation in the q to q results. So long as the derivative contracts are for hedging purposes and not for speculation including them would show the real realization rate or else it beats the purpose of hedging.
That is why you will see in your calculation there is a signficant drop in EBIDTA because you are ignoring hedging profits. If you keep on excluding there will be a huge variance in the comparative figures Q to Q and Y to Y.
The purpose of hedgding is to mitigage forex risks. So if you ignore that the very purpose is not served.
Thanks
Hrishikesh
Hi Varadharajan,
The two companies that I talked about are SPS (Scientific Publishing Services) and Newgen…
Rgds.
Hi Hrishikesh,
As I said before too, there can be two views to this and I respect that…however, on your point about volatility in margins because of non-inclusion of forex/gain loss is factually incorrect as it is because of the seasonal nature of the business itself wherein Q3 turns out highest revenue whereas Q1 turns out lowest revenues but the the bench of employees that the company needs to keep and other expenses that the company needs to incur remain constant…hence, there will be always lowest EBITDA margins (from core operations) in Q1 and highest in Q3…but, since you are including forex gain in your calculations, it is an illusion that Q1 margins are at 39 % which seems stable QoQ…this fact you will not realise till the currency goes the other way and that too sharply…however, again I will say that you are not 100 % wrong in including forex above the line as there are many finance guys who do so…but, in my assessment I always like to see the picture w/o including non-core items…
Rgds.
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