Redington India's Q3FY19 results (Outperformer) - Overseas drives Q3 performance; India to follow!

Q3FY19 results highlights (base adjusted for Ind-AS 115)

• Cons. revenue was up 11.7% yoy at ~Rs126.3bn. However, higher enterprise contribution in the India IT business (along with weak base effect) led gross margin expansion of ~70 bps yoy to 6.0% (IDFCe: 5.4%). As a result, gross profit grew 26.8% yoy to ~Rs7.5bn (9% beat) while EBITDA grew 32.1% yoy to ~Rs2.8bn (13% beat).
• EBITDA was supported by inventory provision write-back of ~Rs102m (0.08% of rev.). Credit loss provisions stood at 0.12% of rev. (versus 0.14% in Q2 and 0.26% in Q1), in-line with long-term provision rate.
• ~Rs710m of impairment expense has been booked during Q3 on REDI’s Arena (Turkey) investment. Out of this ~Rs450m is attributable to REDI and the balance booked in minority interest. Also, due to reversal of the Turkish lira (after depreciating in Q2), REDI’s tax rate for the quarter fell to 8.3% (versus 24% yoy; 28% est). These effects, alongside higher interest expense (due to higher working capital) led to adjusted PAT coming in at ~Rs1.9bn (+49.9% yoy; 34% beat).
• NWC increased by 5 days yoy to 41 days (flat qoq), mainly due to higher enterprise IT business (where credit periods were extended due to liquidity issues at customer level). This has also resulted in REDI’s FCF going negative (~Rs4.1bn for 9MFY19). India FCF stood at –Rs6.4bn, while overseas FCF stood at Rs2.3bn for 9MFY19.
• India business grew ~11% yoy (in-line), powered by IT and Services segment (Mobility declined by 9% yoy). Overseas business too grew by ~11% yoy (in-line) powered by Mobility and Services segments. Overseas EBITDA/PAT grew by 60%/29% yoy in this quarter vs India’s EBITDA/PAT growing by 5%/-6% yoy.

Key positives: Gross margin improvement, lower tax rate.

Key negatives: NWC elevated at 41 days led –ve FCF.

Impact on financials: 12% EPS upgrade for FY19E.

Valuation & View

REDI’s Q3 performance was far better than expected on the profitability front. With its India business growth falling in place, and strong overseas performance, we believe that REDI may be entering a phase of healthy growth over the near-term. Potential uptick in enterprise IT spending (signs visible in Q3), mobility business growth (both domestic/overseas), and continued growth of services (ProConnect/Ensure) could mean that REDI’s earnings upcycle should continue over the next 2-3 quarters. We cut our target multiple to 8x (given general weakness of investor appetite towards mid-caps), but believe that current valuations (FY20E P/E and P/B at 4.8x and 0.6x respectively) provide enough margin of safety. We maintain our OP rating with a revised TP of Rs119.