MOSL: KPIT TECHNOLOGIES (Upgrade to Buy)-Engineering traction and Margins beat

KPIT Technologies: Engineering traction and Margins beat; Upgrade to Buy

(KPIT IN, Mkt Cap USD0.6b, CMP INR211, TP INR275, 31% Upside, Upgrade to Buy)

• Performance better than expectations: KPIT’s 2QFY19 revenue grew 2.9% QoQ CC (our estimate: +2.7%), led by strength in Engineering, partly offset by weakness in IT Services. EBITDA margin expanded 150bp QoQ to 13.6% (130bp beat), aided by operational efficiencies, a change in business mix and INR depreciation. Despite the strong operational beat, PAT growth of 6% QoQ (to INR876m) trailed our estimate of +19% due to higher depreciation and lower other income.
• Transaction approvals in progress: KPIT had earlier announced the demerger of its Engineering business, and a merger of the IT Services business with Birlasoft. NCLT approval is expected by year-end. We reckon that the Engineering business would continue delivering 20% CAGR and that the fate of the IT business can change under the larger, focused entity and under new leadership (we conservatively still build in 8% CAGR).
• Demerger would result in value unlocking: We value KPIT's Engineering business at 15x FY20E earnings because of its (i) high growth, (ii) superior margin profile and (iii) positioning in ERD and acclaimed capabilities in Automotive; conservatively at the lower end of peers like CYL, LTTS and TELX. Separately, we value the IT Services business at 11x forward earnings, at the bottom quartile of peers, given its limited history to lay confidence on and past issues in performance.