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3i Infotech: Powering ahead - Views on News from Equitymaster

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3i Infotech: Powering ahead
Jul 26, 2006

Performance summary
3i Infotech recently reported its results for the first quarter ended June 2006. The company has witnessed continued strength in both its major businesses, viz. products and services, which has led to a good performance on the topline sequentially. Margins saw a strong expansion due to lower cost of revenues and SG&A expenses. The margin expansion, coupled with higher other income and a lower effective tax rate, led to an impressive sequential growth in the company’s bottomline for the quarter.

Consolidated financial performance: A snapshot
(Rs m) 4QFY06 1QFY07 Change
Revenues 1,200 1,285 7.1%
Expenditure 944 991 5.0%
Operating profit (EBDITA) 255 293 14.8%
Operating profit margin (%) 21.3% 22.8%  
Other income 16 48 196.9%
Depreciation 65 79 21.3%
Interest 25 32 28.8%
Profit before tax 182 230 26.6%
Extraordinary items 9 -  
Tax 16 17 7.9%
Minority interest 1 -  
Profit after tax/(loss) 175 214 21.9%
Net profit margin (%) 14.6% 16.6%  
No. of shares (m) 53.0 53.2  
Diluted earnings per share (Rs)*   12.9  
P/E ratio (x)*   11.1  
* On a trailing 12-month basis.

What is the company’s business?
3i Infotech is an IT company focussing mainly on the banking, financial services and insurance (BFSI) vertical. It was incorporated in 1993 as a back-office IT services provider to the ICICI Group and has since metamorphosed into a technology company providing IT services and solutions to over 500 clients in over 30 countries. 3i Infotech earns revenues from products as well as IT services. The company has products for the BFSI space, with a presence in insurance, treasury, asset-liability management, risk management, core banking and investment management. It also has an ERP product suite, providing solutions for the retail, manufacturing, distribution, trading, fashion, automotive, pharmaceutical and chemical industries. Its main focus in IT services is in the region of enterprise application integration, systems integration, security consulting and e-governance. The company acquired four companies in FY06 with a focus on business intelligence, security consulting, anti-money laundering software, ERP software and a mutual fund product.

What has driven performance in 1QFY07?
All-round buoyancy aids the topline: In 1QFY07, 3i Infotech witnessed strong 7.1% sequential growth in its topline. The major growth drivers for this performance were strong performances of both the company’s businesses – products and services. While the products business grew at a sequential rate of 8.2%, services saw a 6.0% QoQ growth.

In the products business, it was the BFSI products segment that was the major driver for growth. This business grew at as much as 28.3% QoQ. 3i Infotech continues to witness strong traction in this business, adding as many as 17 new clients for its banking and insurance products during the quarter. The products business has good revenue visibility, as can be gauged from the accretion to the order book. At the end of 1QFY07, 3i Infotech had an order book size of Rs 1,465 m in its products business (Rs 710 m at the end of 1QFY06). This signifies a more than doubling of the order book size a year ago, and is a clear pointer that this business segment will be the major growth driver for the company’s products business in future. However, the ERP products business saw de-growth of 30.8% QoQ. Taken on a year-on-year basis, BFSI products grew at as much as 69.2% YoY and ERP products grew at a decent 24.0% YoY.

The services business, on the other hand, clocked a 6.0% QoQ growth in revenues. This was driven by the ‘Others’ segment, which grew at 17.3% QoQ. The ICICI Group revenues, on the other hand, grew at a smart 9.5% QoQ. The company continues to focus on areas such as systems integration, e-governance, security consulting and enterprise application integration (EAI).

Going forward, revenue visibility is good, with the total outstanding order book at Rs 1,465 m in the products business (Rs 710 m at the end of 1QFY06) and at Rs 1,467 m in the services business (Rs 1,279 m at the end of 1QFY06). Client metrics have improved as well, with the ICICI Group now contributing to 18.7% of total revenues (23.4% in 1QFY06). The company has improved its client management as well, with as many as 21 clients giving it revenues in excess of US$ 1 m (12 at the end of 1QFY06). This is a clear indication that 3i Infotech continues to invest in client mining efforts.

Segment-wise performance…
(Rs m) 4QFY06 % of total 1QFY07 % of total Change
Products
Revenues 580 48.4% 628 48.9% 8.2%
Gross profit 306 57.4% 330 56.1% 7.9%
Gross margins 52.7%   52.5%   -0.1%
Services
Revenues 620 51.6% 657 51.1% 6.0%
Gross profit 227 42.6% 258 43.9% 13.6%
Gross margins 36.6%   39.2%   2.6%
Total
Revenues 1,200   1,285   7.1%
Gross profit 533   587   10.3%
Gross margins 44.4%   45.7%   1.4%

Margins power ahead: 3i Infotech saw a strong 154 basis points expansion in its margins. This was enabled due to lower cost of revenues, which declined as a percentage of sales to 54.3% (55.6% in 4QFY06). Even on the selling, general and administrative (SG&A) side, these expenses reduced as a percentage of sales to 22.9% (23.1% in 4QFY06). This enabled operating margins to hit 22.8%. The company’s vision is to hit around 25% margins by FY08, and the progress that it has made with each quarter gives us confidence that there is a strong possibility of 3i Infotech achieving this target. As regards segmental margins, product gross margins marginally fell QoQ by 14 basis points, while services margins increased by 262 basis points.

Higher margins, other income drive the bottomline: Apart from margin expansion, higher other income (up by as much as 196.9% QoQ) enabled the bottomline to clock an impressive 21.9% QoQ growth. The effective tax rate (on PBT) also reduced to 7.3% this quarter (8.5% in 4QFY06). If we take a year-on-year basis, the net profit has grown by as much as 107.4% YoY.

Performance in the recent past…
  2QFY06 3QFY06 4QFY06 1QFY07
Sales growth (%, QoQ) 11.9 15.0 7.1 7.1
Operating margins (%) 20.5 20.9 21.3 22.8
Profits growth (%, QoQ) 11.7 22.0 7.6 21.9

What to expect?
At the current price of Rs 143, 3i Infotech’s stock is trading at a price to earnings multiple of 11.1 times its trailing 12-month earnings. The company continues to see strong visibility in revenues in both the products as well as the services businesses. If we take a look at the performance over the past few quarters table above, a distinct improvement in margins is seen. We expect this to continue going forward, driven by higher product sales in total revenues and lower SG&A expenses.

In 1QFY07, 3i Infotech made a strategic investment of Rs 50 m for a 51% stake in a company called Delta Services (India) Pvt. Ltd. This company operates in the BPO space in the banking and financial services domain. Thus, this is a clear signal of intent, reflecting the company’s intentions to tap the fast-growing BPO space in a more meaningful manner. This is part of the longer-term vision of the company to become a total solutions provider, with an approximate revenue mix of 50:50 between products and services. All other recent initiatives on the acquisitions front are with a view to broadening the company’s product offerings to the BFSI space (SDG – Anti-money laundering and capital markets, Datacons – mutual funds).

The management has reiterated it’s guidance for a growth of between 25% and 30% in revenues and for earnings per share (EPS) to be in the range of Rs 13.0 to Rs 13.5 (after preference dividend) in FY07. We are enthused by the initiatives that the company is taking to become a complete solutions provider and maintain our positive view on the stock.

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