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Satyam: Signs of sustainability?

Apr 21, 2005

Introduction to results
Satyam has announced strong results for the fourth quarter and full year ending March 2005. While the topline for 4QFY05 has witnessed a decent 7% sequential growth, full year topline grew by as much as 38% YoY. Margins have remained flat for 4QFY05, but have reduced by 180 basis points for the full year due to a high increase in employee costs. Net profit has grown by as much as 25% for 4QFY05 on a sequential basis and for the full year, it has risen by 39% YoY.

Financial performance (Consolidated): A snapshot…
(Rs m)3QFY054QFY05ChangeFY04FY05Change
Sales 9,074 9,715 7.1% 25,605 35,208 37.5%
Expenditure 6,844 7,332 7.1% 18,832 26,527 40.9%
Operating profit (EBDIT) 2,230 2,383 6.8% 6,773 8,682 28.2%
Operating profit margin (%)24.6%24.5% 26.5%24.7% 
Other income 22 298 1254.5% 751 868 15.7%
Interest 2 2 -3.6% 10 9 -10.7%
Depreciation 282 300 6.3% 1,150 1,133 -1.5%
Profit before tax1,9672,37820.9%6,3638,40832.1%
Tax 289 283 -2.2% 1,063 1,176 10.6%
Extraordinary items (0) 2   (37) (22) 
Share of loss in associate companies (29) (35)  (129) (94) 
Profit after tax/(loss) 1,649 2,062 25.0% 5,134 7,116 38.6%
Net profit margin (%)18.2%21.2% 20.1%20.2% 
No. of shares 317.6 319.3   314.5 319.3  
Diluted earnings per share* (Rs)20.725.8 16.122.3 
P/E ratio (x)     17.8  
(* annualised)      

Fourth largest software services exporter
Satyam is one of the leading players in the Indian software services space and its offerings include software development and maintenance (54% of revenues), consulting and enterprise business solutions (35%), extended engineering solutions (7%) and infrastructure management services (4%). Satyam also provides BPO services through its subsidiary, Nipuna. Over the past couple of years, the company has managed to move up the software value chain, as is visible from the rapid growth in the high-end service of package implementation. The contribution of this service has been consistently increasing over the past few years and now constitutes a major portion of revenues.

What has driven performance in FY05?
Rise in volumes helps topline growth:  A combination of a healthy growth in volumes and a marginal increase in billing rates, particularly domestic billing rates, have been the major drivers of the strong 37.5% YoY revenue growth during FY05. Given the fact that the rupee did appreciate slightly against the dollar during 4QFY05, which would have impacted revenues to an extent, it is clear that volumes have been the key driver of the sequential as well as the full-year growth. On the basis of segments, the consulting and enterprise business solutions business (47.8% YoY) contributed the maximum to Satyam’s topline growth during FY05, followed by the software development and maintenance business (25.5% YoY). Satyam added 28 customers in 4QFY05 (28 in the previous quarter). Its active client base now stands at 390.

Satyam has acquired a company called Citisoft, a specialised business and systems consulting firm focussed on the Investment Management industry for US$ 38.7 m, including a US$ 23.2 m payment guaranteed and the balance being an additional performance-based payment, both payable over a period of three years.

Higher employee costs, lower utilisation impact margins:  Although margins were largely flat for 4QFY05 on a QoQ basis, for the full year, they fell by 180 basis points due to higher employee costs, which as a percentage of sales increased from 52.5% in FY04 to 57.5% this fiscal. Utilisation rates also fell, particularly on the offshore and domestic fronts, leading to a negative impact on the company’s margins. The reduction in utilisation levels has been a consequence of the relatively faster pace of hiring in 4QFY05, which saw the company add a net of 1,499 employees (793 in 3QFY05). Satyam has traditionally been less aggressive than its peers like Infosys and Wipro in this regard. The company now has 19,164 employees on its rolls. In comparison, Infosys had 36,750 and TCS had 45,714 employees on their rolls at the end of FY05.

Higher other income leads to strong net profit growth:  A sharp rise on the other income front has helped Satyam post an impressive 25.0% QoQ net profit growth in 4QFY05. If the effect of other income is taken away, sequential growth slows down to a more sedate 8.4%. For FY05, the company has managed to post an impressive 38.6% YoY growth in net profits, driven by higher other income, lower depreciation and lower growth in taxes paid.

Performance in the recent past
 1QFY052QFY053QFY054QFY05
Sales (QoQ growth, %) 7.8 10.5 5.3 7.1
Employee costs (% of sales) 56.4 57.5 58.1 58.1
Operating margins (%) 24.9 24.7 24.6 24.5
Profits (QoQ growth, %) 21.9 8.0 (6.8)25.0
Employees (Nos.) 15,631 16,872 17,665 19,164

What to expect?
At the current price of Rs 396, the stock is trading at a price to earnings multiple of 17.8 times FY05 earnings. The board has recommended a final dividend of Rs 3 per share (dividend yield of 0.8%). The company is also coming out with a sponsored ADR issue of 15 m ADRs (30 m shares) in order to improve the liquidity of the stock on the US bourses. The management has guided for a 26%-28% growth in consolidated revenues (including the Citisoft acquisition) and a 20%-22% growth in earnings for FY06. Based on the growth expectations, EPS is likely to be in the range of Rs 26.8 to 27.3 per share.

While we are positive about Satyam’s forays into the high-end package implementation business, our concerns lie in the fact that the company has consistently under-performed its peers in the past. However, the company does appear to have started to show some sort of consistency in its performance over the past few quarters. The management had made some ill-judged investment decisions in previous years and this appears to be a thing of the past, as the company has been consciously pruning the number of subsidiaries under its fold and cutting down investments in loss-making affiliates. As far as valuations are concerned, given the fall in the stock price recently, they have begun to look attractive from a long-term perspective. However, our top picks in the sector remain the top rung companies like Infosys.

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