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Digital: Parent led growth - Views on News from Equitymaster
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  • Jul 22, 2003

    Digital: Parent led growth

    Digital Globalsoft announced its results yesterday. The company has reported a sequential topline growth of 11% for 1QFY04. Profits for the company have shown a marginal growth of 0.5% for the same period. However, operating margins have been almost stable in this quarter.

    Rs m 4QFY03 1QFY04 Change
    Sales 1,215 1,350 11.1%
    Other Income 57 53 -7.2%
    Expenditure 886 985 11.2%
    Operating Profit (EBDIT) 329 365 10.9%
    Operating Profit Margin (%) 27.1% 27.0%  
    Interest 1 1  
    Depreciation 56 78 38.7%
    Profit before Tax 329 339 3.0%
    Extraordinary items 0 -7  
    Tax 29 30 5.6%
    Profit after Tax/(Loss) 300 302 0.5%
    Net profit margin (%) 24.7% 22.4%  
    No. of Shares 33.0 33.3  
    Diluted Earnings per share* (Rs) 36.1 36.3
    P/E Ratio (x)   12  
    (* annualised)      

    Topline growth for Digital in 1QFY04 was chiefly driven by increased utilization and growth in revenues from its parent, HP. The total HP-related business witnessed a 16% growth QoQ. However, revenues from Digital’s other (non-HP) clients declined by 5%. This has marginally pared revenue growth for Digital. In 1QFY04 these contributed to 19% of revenues compared to 23% contribution in 4QFY03. While Digital had been trying to reduce dependence on parent HP by increasing revenues from its non-HP clients, the ongoing merger with HP-ISO is likely to see increasing revenues from the parent.

    For Digital, the most notable feature for 1QFY04 was the substantial 86% sequential growth in revenues from Digital Contact Centre (DCC), its ITES business. However, product sales for the company declined by 43% sequentially. The company added 22 new clients in this quarter – 20 for the services business, and 2 in the products business. The strong growth from DCC has resulted in the onsite-offshore mix of revenues moving significantly towards the offshore segment (from 38% in 4QFY03 to 44% this quarter). This has been one of the major reasons why the decline in operating margins was very marginal. Going forward, margins could improve if the shift towards the offshore component increases further. However, this is likely to take some more time as Digital still generates a high amount of its service revenues from parent HP, and this mainly involves onsite work.

    Share of revenues…
    Offerings 4QFY03 1QFY04 Change
    eApplications 478 39.3% 540 40.0% 13.0%
    Systems Engineering 172 14.2% 169 12.5% -1.7%
    Enterprise Solutions 338 27.8% 357 26.4% 5.6%
    eInfrastructure 125 10.3% 124 9.2% -0.8%
    Telecom 32 2.6% 45 3.3% 40.6%
    ATG 13 1.1% 27 2.0% 107.7%
    DCC 43 3.5% 80 5.9% 86.0%
    Products 14 1.2% 8 0.6% -42.9%
    Total 1,215 100.0% 1,350 100.0% 11.1%
    ATG- Advanced Technology Group
    DCC- Digital Contact Centre

    On the expenditure front, while staff costs as a percentage of revenue have increased marginally from 49% to 50%, depreciation costs increased substantially by 39%. This, combined with 23% increase in other expenses, has resulted in the lackluster bottomline growth for the company. The operating margins have been maintained mainly on account of stability on the billing-rates front. The ramp up on the DCC business (increase in number of employees, increased training costs, etc.) has also impacted the profits for 1QFY04. The profits have also been impacted marginally owing to Rs 7 m of extraordinary expenses due to the ongoing integration with HP-ISO, which is expected to be completed by the end of FY04.

    Digital seems to be betting high on future growth as can be seen by its doubling up of its human resource during the last year (June’02-June’03). During 1QFY04, Digital added 747 people to its payrolls. This takes the total tally to 3,327 employees as on June 30, 2003. Digital Contact Centre (DCC), in its first year of operation, alone engages around 990 employees (more than double of 481 employees in 4QFY03).

    Digital has maintained its geographical concentration of revenues with the US contributing to around 75%, Europe to 20%, and the remaining 5% coming from other regions. However, there has been a substantial 44% increase in revenues from the US, while those from other regions (excluding Europe) have increased by 62%.

    At the current market price of Rs 452, the stock is trading at a P/E of 12x its 1QFY04 annualized earnings. While the management is projecting higher growth going forward, much is likely to depend on Digital’s integration with HP-ISO. This integration, however, seems to be moving rapidly, as the two have synergized their European marketing operations. Also, the company’s anticipation of future growth can be estimated from the fact that it is ramping up rapidly. While the revenue commitments from parent HP (US$ 215-270 m by FY05) are likely to grow, much will depend on how Digital is able to handle this growth. Thus, considering the high uncertainty of future course of events, the volatility in the stock is likely to be on the higher side.



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