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Digital: Meets expectations - Views on News from Equitymaster
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  • Jul 23, 2002

    Digital: Meets expectations

    Digitalís 1QFY03 net profit growth of 4% (QoQ) is in line with market expectations. However, the company revenues, which have grown by 2.5% sequentially, are a disappointment considering the strong sequential growth reported by majors like Infosys and Wipro on a much larger revenue base. On a YoY basis, the topline growth is 37%, while net profits have grown by 44%.

    (Rs m) 4QFY01 1QFY03 Change
    Sales 938 961 2.5%
    Other Income 53 55 5.1%
    Expenditure 649 669 3.1%
    Operating Profit (EBDIT) 289 292 1.1%
    Operating Profit Margin (%) 30.8% 30.4%
    Interest 1 0
    Depreciation 57 52 -9.6%
    Profit before Tax 284 295 4.1%
    Tax 18 19 7.3%
    Profit after Tax/(Loss) 266 276 3.7%
    Net profit margin (%) 28.4% 28.7%
    No. of Shares (eoy) (m) 32.7 32.7
    Diluted Earnings per share* 32.6 33.8
    P/E (x) 18.0

    The company on a YoY basis has managed to improve operating margins by 1.7%. While the companyís staff costs have shot up by 62% during the year, the margins have improved on the back of lower travel and other costs.

    (Rs m) 4QFY02 1QFY03 Change
    HP 786 711 -
    HP external - 83 -
    Total HP related 786 794 1.0%
    Non-HP 152 167 9.9%
    Total revenues 938 961 2.5%

    HP external refers to service provided to HP for external clients. This classification was not available in 4QFY02. The sequential growth in revenues from parent HP (after the merger of HP and Compaq) was a weak 1%. In past there have been concerns regarding the fallout of the HP-Compaq merger. The low growth in the first quarter post the merger is likely to aggravate the concerns further. HP has a 100% subsidiary in India and fears are that the business might flow to HPís subsidiary instead of Digital. The growth in business was disappointing considering the past performance. The company saw a significant growth in revenues from non-HP clients.

    Service offerings 4QFY02 1QFY03
    % of revenues Rs m % of revenues Rs m Change
    eApplications 37.9% 357 39.4% 379 6.2%
    Systems Engineering 21.1% 199 19.3% 185 -7.0%
    Enterprise Solutions 25.5% 240 25.2% 242 0.8%
    eInfrastructure 11.2% 105 10.8% 104 -1.0%
    Telecom 1.9% 18 2.4% 23 27.8%
    ATG & TSCC* 0.5% 5 0.8% 8 60.0%
    Products 1.8% 17 2.1% 20 17.6%
    Total 100.0% 941 100.0% 961 2.1%

    ATG- Advanced Technology Group
    TSCC- Technical contact Contact Centre

    The break up of revenues based on differing service offering also further strengthens apprehensions. The revenues from systems engineering have declined by 7% sequentially. These services were mostly rendered to Compaqís product line and could have seen a decline due to certain product lines being discontinued as a result of the merger. However, the company claims that the merged parentís focus on services, presents an attractive market opportunity for business enhancement.

    The call centre business (TSCC) saw strong growth in revenues. Product sales for the company improved by 18% sequentially. The contribution of product sales to total revenues was only 2%. The highlight of the performance was the addition of 48 new customers. This includes annual maintenance contracts from 20 customers for the products business. The onsite offshore mix for the company did not change significantly. The company earns 67% of its revenues from onsite projects and the remaining 33% come from offshore projects. The company has significant room to improve margins by changing the mix in favour of offshore revenues. However, this will take quite sometime due the fact that service rendered to the parent are onsite in nature and the revenue concentration will be diluted over a period of time.

    Digital has managed to reduce the geographic concentration of revenues significantly over the year. The revenues from the US were 73% of the total revenues as compared to 80% in 1QFY02. Europe accounted from 22% of the revenues (up from 16% in 1QFY02).

    At the current market price of Rs 607, the stock is trading at a P/E multiple of 18x its 1QFY03 estimated earnings. The company has stuck to its guidance of beating the sector growth rate for FY03. What remains to be seen is whether the merger translates to a bigger revenue opportunity. The lower growth in revenues from the parent could also be due to the fact the things are in a state of flux as the two companies may be sorting out merger related issues. Once that is done the revenues might start to flow in once again, as the management expects. Considering the uncertainty of the future course of events, the element of volatility in the stock price could act as a pinch of salt to valuations.



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