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3i Infotech: One up on peers
Jul 26, 2007

Performance summary
  • Consolidated topline grows 24% QoQ; 13% QoQ on an organic basis (excluding acquisitions).

  • Operating margins contract by 1% largely due to wage hikes.

  • Services grow 37% QoQ and products grows 13% QoQ - growth in the services segment largely driven by acquisition of Professional Access.

  • Bottomline expands by 22% QoQ largely due to higher other income.

Consolidated financial performance: A snapshot
(Rs m) 4QFY07 1QFY08 Change
Sales 2,102 2,603 23.8%
Expenditure 1,577 1,978 25.4%
Operating profit (EBDIT) 525 625 19.1%
Operating profit margin (%) 25.0% 24.0%
Other income 8 39 406.3%
Software development cost 73 78 6.6%
Depreciation 58 48 -17.8%
Interest 61 103 68.0%
Profit before tax 340 435 28.0%
Tax 20 32 62.8%
Minority Interest 2 11
Profit after tax/(loss) 322 392 21.7%
Net profit margin (%) 15.3% 15.1%
No. of shares (m) 56.3 66.3
Diluted earnings per share (Rs)* 18.3
P/E ratio (x)* 16.7
* On a trailing 12-month basis
* On a trailing 12-month basis

What is the company business?
3i Infotech is an IT company focusing 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 45 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, and 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. It 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 1QFY08?
Services drives topline: 3i-Infotech recorded a 24% QoQ growth in its topline during 1QFY08. This was on the back of a good traction in services as well as the products segments. While services notched up a 37% QoQ growth in sales, the products segment delivered a decent performance and recorded a 13% QoQ growth. The services segment now contributes to 53% of the consolidated revenues (up from 49% in 4QFY07) and the company expects to maintain the 50:50 ratio for products and services going forward. The strong performance shown in a difficult quarter was also due to the acquisition strategy adopted by the company, which is now yielding results. As on date, the company has a strong order backlog, which stands at Rs 3.6 bn for services and 2.9 bn for products (executable within a period of 12 months).

In terms of geographies, 3i is heavily concentrated in India (31% revenue share). Due to this, the company's receivables are not that exposed to the volatility in the rupee-dollar rate. During 1QFY08, its India operations recorded a 28% QoQ growth. However, the worrying point is the growing dependence on the US, which contributed to 25% of 3i's consolidated revenues in 1QFY08 (21% in 4QFY07). This makes 3i's receivable more susceptible to currency appreciation, as has been seen in case of its larger peers. Revenue from the US recorded a 47% QoQ growth in this quarter.

On the client side, 3i added four US$ 1 m clients during the quarter and revenue from its top customer (ICICI Bank) remained stable (around 15% mark). On the employee front, the company added a net of 350 employees and the total headcount stood at 5,250 employees with 2,000 people in the products segment and balance in the services segment. The company's attrition rate has also come down from 17% in 4QFY07 to 15% in 1QFY07.

Margins under pressure: 3i's operating margins contracted by 1% QoQ, largely due to contraction in operating margins of the services segment and 10% wage hikes affected during the quarter. Although the wage hike looks smaller when compared with hikes of 15% across the industry, 3i Infotech also gives a 2% to 3% market equalisation allowance to retain key employees. The operating margins of the services segment contracted from 39.4% in 4QFY07 to 39% in 1QFY08. The impact was bigger mainly because the contribution of the services to total revenue has increased. This is not specific to the company as the services segment across the industry is facing margins pressures. On the positive side, operating margins of the products segment increased from 54% in 4QFY07 to 55% in 1QFY08. This is a positive tool on 3i's side as it is among the very few companies in the Indian IT industry, which has a good blend of products and services revenues.

One thing worth noting here is that 3i has not been significantly impacted due to the appreciation in rupee. This is because the company derives 25% of its revenues from the US markets and 20% of its costs are in US dollar terms, thereby almost negating the volatility in the rupee-dollar rate.

Segment wise performance
(Rs m) 4QFY07 % of total 1QFY08 % of total % change
Products
Revenues 1,076 51.0% 1,219 46.1% 13.3%
Gross profit 580 58.7% 669 54.7% 15.5%
Gross margins 53.9% 54.9%
Services
Revenues 1,034 49.0% 1,423 53.9% 37.7%
Gross profit 408 41.3% 555 45.3% 36.2%
Gross margins 39.4% 39.0%
Total
Revenues 2,110 2,642 25.2%
Gross profit 987 1,224 24.0%
Gross margins 46.8% 46.3%

Higher other income, lower depreciation aids bottomline: 3i-Infotech's net profits grew by 22% QoQ during 1QFY08. This was largely due to the strong growth in other income and lower depreciation expenditure. On the taxation front, the company's effective tax rate increased from 5.8% at the PBT level to 7.3%.

Performance over the recent past
Particulars (%) 1QFY07 2QFY07 3QFY07 4QFY07 1QFY08
Sales growth (QoQ) 7.1 12.9 18.3 22.5 23.8
Operating margins 22.8 23.5 24.8 25.0 24.0
Profits growth (QoQ) 21.9 5.5 22.2 -18.7 21.7

What to expect?
At the current price of Rs 307, the stock is trading at a multiple of 7.3 times our estimated FY10 earnings. The company has managed to record a strong performance during this quarter, which has otherwise been harsh on its larger peers owing to the rupee appreciation against the US dollar as also due to wage pressures. A large order book also supplements our argument as the company has performed fairly well on the execution front. Secondly, we believe that going forward the company's vision of maintaining 50:50 mix between products and services will help it achieve above normal growth than its peers. We maintain our positive recommendation on the stock from a long-term perspective.

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