Outsourcing revival to boost Infotech

Revival in outsourcing spend by engineering companies brings good news for IT companies like Infotech Enterprises, which has strong domain knowledge and expertise in engineering services.

Business
Infotech is a mid-tier global IT services provider offering engineering design, geospatial and software solutions. The company headquartered in Bangalore has over 8,300 employees across 30 global locations.

The company’s business can be broadly divided into two segments—-network & content engineering (NCE) and engineering, manufacturing and industrial products (EMI).

NCE: This segment was earlier known as UTG catering to geospatial information services for utilities, telecommunications and government domains. The company has, however, diversified since then to offer wider services including strategic consulting; network design, planning and analysis; operational support; network management and optimisation; geospatial and asset management; data accumulation, content aggregation and enterprise content management.

This segment catering to clients in industries such as power, gas, telecom, transportation and local government, contributes almost one third to consolidated revenues.

EMI: The company offers detailed design, installation support, product development and lifecycle management services and process services related to mechanical, electrical, electronics and manufacturing engineering apart from technical publications. This segment contributes almost two thirds to consolidated revenues.

Investment rationale: 2010 has seen a significant increase in the amount being budgeted or being spent by customers towards outsourcing engineering and IT solutions which is likely to continue in 2011 as well.
The engineering companies in aerospace, rail, heavy engineering and hi-tech domains are likely to support volume growth as there has been trend of increased budgets in regions like Asia Pacific and North America.  Infotech being one of the leading global engineering services provider is well set to benefit from this higher spend.

The company has some of the top customers in its fold as its client list includes 22 fortune 500 companies and 27 global 500 organisations. The company has a diversified clientele as well with top 5 customers contributing around 37% and top 10 customers accounting for 56% of consolidated revenues.

Geographically, the company derives close to 55% of its consolidated revenues from North America while Europe and Asia Pacific contribute 37% and 8%, respectively, to the topline.

The company that has made two acquisitions last year—-Daxcon Engineeering, US and Wellsco—-is likely to see improvement in operating margins in the coming quarters as these acquired companies start doing more offshore jobs resulting in margin improvement.

It has also been facing operating margin pressures due to foreign currency fluctuations and pricing pressure.

But going ahead, the company is likely to see better pricing as it has manged to get price hikes of 3-5% from its top three customers starting from January 2011.

Infotech has a strong order pipeline as it keeps on engaging new customers (added 15 new customers last quarter with 8 in EMI segment and 7 in NCE segment). The company is also focusing to improve its utilisation levels which currently stand at 75-80% and improve its offshore on shore mix to improve the margins apart from recruiting freshers to lower its average employee costs.
The company which has a strong balance sheet with cash balance of around Rs381 crore, is also having an active mergers and acquisitions (M&A) pipeline in Europe and USA, some of which have potential to close in 2-3 quarters.

Concerns: The company faces industry-specific risks related to foreign exchange fluctuations, attrition, not getting suitable manpower and slowdown in engineering spend in low growth economies like Europe.

Valuations: Driven by addition of new clients and volume growth, the company’s revenue are expected to grow at CAGR of over 24% over FY10-FY12E while the net profits which have taken a hit due to decreased operating margins this year are expected to recover to Rs180 crore in FY12E.

At current market price of Rs160, the stock of Infotech Enterprises trades at 12.54 times its expected FY11 earnings and at 9.9 times its FY12 earnings per share. Investors with medium to long-term perspective can look to add the stock on every decline.

Disclaimer: The writer does not hold any share in the company