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Digital: What slowdown? - Views on News from Equitymaster
 
 
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  • Apr 25, 2002

    Digital: What slowdown?

    Digital has posted an 80% growth in topline for FY02, in a year when the software industry is likely to post growth of 20% to 22%. However, increased depreciation and taxes limited the bottomline growth to 71% for the fiscal. The company has far outperformed the 50% topline guidance it had given for FY02. A steady revenues flow from its parent Compaq is largely responsible for the remarkable performance.

    The 4QFY02 numbers were in line with expectations. The topline grew by 7% and the rise in bottomline was 8%, sequentially. However, rising employee and miscellaneous costs have taken a toll on Digital’s operating margin. But this decline was offset by a sharp rise in other income.

    (Rs m) 3QFY01 4QFY01 Change FY01 FY02 Change
    Sales 873 938 7.4% 1,843 3,317 80.0%
    Other Income 25 53 106.7% 130 136 3.9%
    Expenditure 578 649 12.3% 1,343 2,281 69.8%
    Operating Profit (EBDIT) 295 289 -2.0% 499 1,036 107.4%
    Operating Profit Margin (%) 33.7% 30.8%   27.1% 31.2%  
    Interest 0 1   - 1  
    Depreciation 31 57 87.2% 67 132 98.1%
    Profit before Tax 289 284 -1.9% 563 1,039 84.5%
    Tax 43 18 -58.4% 20 112 461.3%
    Profit after Tax/(Loss) 247 266 7.9% 543 928 70.7%
    Net profit margin (%) 28.3% 28.4%   29.5% 28.0%  
    No. of Shares (eoy) (m) 32.7 32.7   32.7 32.7  
    Diluted Earnings per share* 30.2 32.6   16.6 28.4  
    P/E (x)   20.8     23.9  
    *(annualised)            

    Client concentration – diluting
    The contribution to the total revenues from Compaq declined from 88% in FY01 to 85% in FY02 as growth in revenues from non-Compaq clients grew at a blazing 138% compared to a 72% rise in revenues from its parent company. Even in this difficult business environment the growth in revenues from non-Compaq clients at 19% sequentially outpaced revenues from Compaq that grew by 6%. The share of revenues from Compaq was 84% of the total revenues in 4QFY02. The company has been aggressively trying to mitigate this single biggest concern with its business model.

    The impact of the HP-Compaq merger is still unclear. According to the company’s press release, ‘the structure of the company’s operation (Digital’s operations) in light of this development (HP-Compaq merger) is still pending’. This could be a good reason to avoid the stock till the fallout of the merger becomes clear.

    Service offerings
    In 4QFY02, the company saw growth stemming for systems engineering and enterprise solutions. The demand for e-commerce related solutions continued to be subdued and showed a marginal decline. Weakness from the telecom segment was evident from the 14% decline in revenues. The other numbers are not exactly comparable on a YoY basis since the company did not have the enterprise solutions division in FY01 and certain revenues stream that are now a part of the enterprise solutions divisions were earlier booked under other divisions.

    % Contribution 3QFY01 4QFY01 Change FY01 FY02 Change
    e-Applications 42.0% 38.1% -2.5% 51.2% 41.8% 46.9%
    Systems engineering 20.0% 21.2% 11.2% 23.4% 20.0% 53.9%
    Enterprise solutions 23.0% 25.6% 21.8% 0.0% 23.1% -
    e-Infrastructure 12.0% 11.2% -0.9% 19.8% 11.4% 3.6%
    Telecom 2.0% 1.9% 12.5% 5.8% 2.7% -14.3%
    ATG 1.0% 0.5% 0.0% - - -

    The revenues from onsite projects grew by 90% in FY02 as compared to 60% growth in revenues from offshore projects. Consequently, the contribution of onsite revenues increased from 64% in FY01 to 68% in FY02. The share of offshore revenues decreased from 36% to 32% during the fiscal. The company has managed to improve margins inspite of revenues mix changing in favour of onsite projects that traditionally earns lower margins.

    The company recorded significant growth of 159% in revenues from Europe. With the slowdown in the US (traditionally the largest market for the Indian software sector), the software companies concentrated on strengthening business from Europe. Thus a large number of companies have seen a sizable increase in revenues from the European geography. US and Asia Pacific geographies grew at almost the same rate during the year at 68%.

    FY03 guidance- Fog on the windscreen
    The management has taken a prudent stand as far as the guidance for FY03 is concerned. All the company has said is that it will beat the sector growth rate for FY03. The management has probably refrained from giving guidance due to the overall uncertainty in the US economy and the uncertainty over Digital’s role post the HP-Compaq merger. However, the company’s foray into IT enabled services through technical support call centres could add pace to the topline.

    At the current market price of Rs 677, the stock is trading at a P/E multiple of 24x its FY02 annualised earnings. The company’s prudence in not giving out a clear FY03 guidance may hit valuations as swift growth in FY03 may already be factored in the stock price.

     

     

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