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i-flex: Sustenance is the key

Jan 28, 2005

Introduction to results
i-flex solutions (i-flex) has reported strong results for the quarter and nine-month period ending December 2004. For 3QFY05, while topline has grown by 44% YoY, the bottomline is up 27%. Higher cost of revenues have, however, taken a toll on operating margins, which have declined by 270 basis points over the third quarter of FY04. The performance is strong on a QoQ basis as well, with revenues and profits growing by 17% and 9% respectively.

Consolidated financial performance: A snapshot
(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change
Net sales 2,084 3,000 44.0% 5,788 7,799 34.7%
Expenditure 1,571 2,344 49.2% 4,190 6,066 44.8%
Operating profit (EBDITA) 512 656 28.0% 1,598 1,733 8.4%
Operating profit margin (%) 24.6% 21.9% 27.6% 22.2%
Other income 63 (13) -121.3% 121 138 14.0%
Depreciation 36 81 125.9% 98 210 115.1%
Profit before tax 540 562 4.0% 1,622 1,661 2.4%
Tax 183 107 -41.4% 381 375 -1.5%
Profit after tax/(loss) 356 454 27.4% 1,241 1,286 3.6%
Net profit margin (%) 17.1% 15.1% 21.4% 16.5%
No. of shares (m) 77.3 76.8 77.3 76.8
Diluted earnings per share (Rs)* 18.6 23.6 21.5 22.3
P/E ratio (x) 27.4
(* annualised)

What is the company's business?
i-flex is a focused player in the banking and financial services vertical. The company's portfolio of offerings comprises products (53% of revenues), like Flexcube, an end-to-end product suite for retail, corporate and investment banking and asset management. Also, the company provides software services (47% of revenues) like application software development and deployment, maintenance and business and IT consulting. In FY04, the company's flagship product, Flexcube, was ranked as the number one selling wholesale as well as retail back-office banking solution in the world by International Banking Systems (IBS) for the second year in running. In fact, Flexcube had been rated among the top-selling banking solutions for the last five years.

What has driven performance in 3QFY05?
Across the board growth:  i-flex's services segment (47% of revenues) continues to lead the growth in the company's consolidated topline if one is to consider the performance on a YoY basis. In 3QFY05, while revenues from the segment have increased by 68% YoY, those from the products division have grown by 28%.However, on a QoQ basis, product revenues growth (25% QoQ) has clearly outperformed growth in services revenues (10% QoQ). More important, the strong growth in both these segment is a positive for the company that has been trying to cross-sell its offerings across the customer base. The robust growth in the services segment is, however, fallout of the management's consistently push for faster growth of the segment, as it acts as an incubator for developing new technology that will further help the company in improving its product offerings.

Services revenue growth (on a QoQ basis) was aided by improvement in billing rates for both onsite and offshore services. While rates for onsite services grew QoQ by 6%, those for offshore improved by a strong 14%. In 3QFY05, i-flex added 12 and 4 customers in the products and services businesses respectively (9 and 15 in 2QFY05). The strong client addition in the product space is indicated in the increased share of license fee (35%, from 30% in 2QFY05) in i-flex's product revenues.

Segment-wise performance…
  3QFY04 % of total 3QFY05 % of total Change
Revenue 1,248 59.9% 1,595 53.2% 27.8%
OP 491 75.3% 562 68.5% 14.4%
OPM 39.3%   35.2% 4.1%  
Revenue 836 40.1% 1,404 46.8% 67.9%
OP 161 24.7% 258 31.5% 60.2%
OPM 19.2%   18.4% 0.9%  
Revenue 2,084   2,999   43.9%
OP 652   820   25.7%
OPM 31.3%   27.3%    
* including inter-segment adjustments

High cost of revenues dent margins:  i-flex has added a net of 1,492 employees in the last four quarters, which is the largest YoY addition in the past four quarters. This seems to have resulted in an increase in the company's cost of revenues (as % of sales), which has dented its operating margins for the quarter. As a matter of fact, from 44% of revenues in 3QFY05, cost of revenues has increased to 53% in 3QFY05. This seems to have had an effect on both the segments. While margins for products have declined by 410 basis points to 35% in 3QFY05, those for services are lower by 90 basis points to 18%.

Lower other income pares net profit growth:  Apart from the contraction in operating margins, lower other income has dented the net profit growth. While the company has not yet indicated the reason for this decline, we believe that this might have been a consequence of the around 4% appreciation of the Indian rupee vis-à-vis the US dollar, as has been the case with other software players. Strong rise in depreciation costs has also pared profit growth in this quarter.

Performance in recent times
  4QFY04 1QFY05 2QFY05 3QFY05
Sales growth (%, YoY) 25.7 22.2 36.8 44.0
Operating margins (%) 30.0 23.0 22.0 21.9
Profits growth (%, YoY) 42.8 8.9 (16.3) 27.4
Products (YoY, %) 21.2 6.0 13.5 27.8
Services (YoY, %) 42.1 52.6 72.0 67.9

Key events in this quarter

  1. As part of its inorganic growth strategy, i-flex acquired Equinox Corporation and a 33% stake in the France based Login SA. While the former will provide the company expertise in solutions for the mortgage industry, the latter is a treasury software specialist. Effect of these acquisitions is yet to be seen on i-flex's performance.

  2. The company announced the availability of Flexcube on Linux, which is likely to reduce the total cost of ownership for clients. Also, the company, along with IBM, announced the availability of Flexcube on the latter's software platform. i-flex and IBM will jointly market this enhanced version of Flexcube. As per company sources, initially, this version on the IBM platform will be available for retail-banking functions.

What to expect?
At the current price of Rs 611, the stock is trading at a price to earnings multiple of 27.4 times annualised 9mFY05 earnings, which is at the higher end of the valuation spectrum. Inspite of a strong performance in 3QFY05, the company does not seem in line with meeting our earnings expectations for FY05. As such, we will soon take a re-look at our assumptions and update our research report on the company. While the strong growth in services has been a key growth driver in the nine-months of this fiscal, margins have been highly volatile on account of the company's increased investments in employees and marketing network. While we believe that consistent spending on growth initiatives would help the company in tiding over competition and penetrating wider markets, the fact that performance of the high-margin products front has been volatile in the recent past is a cause of concern. Perhaps this explains the risk profile of product companies.

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