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Indian engineering research and development (ER&D) players, such as Tata Technologies, Tata Elxsi, and Cyient, among others, had a subdued January-March quarter of 2023-24.
The outlook for 2024-25 (FY25) also remains unexciting amid weak discretionary spending, prompting analysts to revise their growth expectations for the ongoing financial year (FY25).
“We have cut FY25 earnings across companies by 2-9 per cent.
"The near term is not very encouraging with a moderate growth outlook due to weak spends by clients, elongated sales cycles, and limited visibility on the conversion of the order book,” Kawaljeet Saluja, Vamshi Krishna, and Sathishkumar S of Kotak Institutional Equities (KIE) wrote in a recent report.
Except for KPIT Technologies, which is continuing to benefit from tailwinds in the automotive (auto) sector and strategic partnerships with original equipment manufacturers, most ER&D players saw either flat or declining margins on a sequential basis.
Tata Elxsi and L&T Technology Services (LTTS) earnings before interest and tax (Ebit) margins fell by 100 basis points (bps) and 30 bps, respectively.
Others including Tata Technologies, Cyient, and KPIT largely recorded flat Ebit margins on a quarter-on-quarter basis.
This, coupled with disappointing FY25 guidance from the management, has prompted caution among analysts.
Tata Elxsi and Cyient constant currency revenues, at Rs 905 crore and Rs 1,489 crore, respectively, were lower than expected while KPIT, LTTS, and Tata Technologies reported in-line numbers.
InCred Capital has also revised its FY25 earnings estimates from mid-double-digit growth to high single-digit growth for companies under their coverage.
“High single-digit growth takes into account the companies’ FY25 order book, macroeconomic environment, and our interactions with the management. KPIT, followed by Persistent Systems, may outperform,” said Abhishek Shindadkr, equity analyst at InCred Capital.
Analysts believe companies having higher exposure to auto and aerospace may shine amid a weak environment in FY25, but those with higher exposure to telecommunications service providers may remain on the weaker side.
Valuation play
On the bourses, share prices of pure-play ER&D players like Cyient, Tata Elxsi, LTTS, Tata Technologies, and KPIT have seen a deep correction of 24.8 per cent, 18.6 per cent, 17 per cent, 14.4 per cent, and 3.3 per cent, respectively, so far in the current calendar year.
By comparison, the S&P BSE Sensex has gained 0.5 per cent during the period.
Yet, most of the ER&D players are commanding price-to-earnings (P/E) multiples of 20-25 times as, after the pandemic, these companies saw a significant rerating.
At present, Cyient is trading at a P/E multiple of 38.39 times, KPIT at 122.71 times, LTTS at 36.66 times, and Tata Elxsi at 56 times, shows BSE data.
By comparison, their five-year P/E averages were in the range of 20-71 times.
Given this, analysts at KIE have maintained their ‘sell’ rating on LTTS, KPIT, Tata Elxsi, and Tata Technologies factoring in unrealistic long-term growth expectations.
Shindadkr of InCred Capital, however, has a ‘hold’ rating for LTTS and ‘add’ for Cyient.
“In my opinion, one should consider higher exposure to larger, diversified and reasonably valued names like LTTS and Cyient, and then top up with concentrated, high growth and expensive names like KPIT and Tata Elxsi,” said Mohit Jain, research analyst at Anand Rathi Institutional Equities.
