Digital’s 2QFY03 numbers are significantly below expectations. The company has posted a 1% sequential decline in revenues. But the real disappointment is the net profit figure that has fallen 23% (QoQ). On a YoY basis, the topline is up 18%, while the net profits have fallen by 4%.
(Rs m) | 1QFY03 | 2QFY03 | Change | 1HFY02 | 1HFY03 | Change |
Sales | 961 | 949 | -1.3% | 1,510 | 1,910 | 26.4% |
Other Income | 55 | 30 | -44.9% | 58 | 86 | 47.3% |
Expenditure | 669 | 688 | 2.8% | 1,057 | 1,357 | 28.3% |
Operating Profit (EBDIT) | 292 | 261 | -10.6% | 453 | 553 | 22.0% |
Operating Profit Margin (%) | 30.4% | 27.5% | 30.0% | 28.9% | ||
Interest | 0 | 1 | 0 | 1 | 125.0% | |
Depreciation | 52 | 63 | 22.9% | 45 | 115 | 157.3% |
Profit before Tax | 295 | 228 | -23.0% | 466 | 523 | 12.1% |
Tax | 19 | 14 | -27.7% | 51 | 33 | -35.9% |
Profit after Tax/(Loss) | 276 | 214 | -22.7% | 415 | 490 | 18.1% |
Net profit margin (%) | 28.8% | 22.5% | 27.5% | 25.6% | ||
No. of Shares (eoy) (m) | 32.7 | 32.7 | 32.7 | 32.7 | ||
Diluted Earnings per share* | 33.8 | 26.1 | 25.4 | 29.9 | ||
P/E (x) | 18.0 | 15.70 | ||||
*(annualised) |
While a sharp fall in other income is largely responsible for the decline in net profits, a steep dip in other income is also equally responsible. The operating margins have fallen due to a sequential rise of 6% in employee costs. However, the company did manage to control costs. The ‘other’ expenses declined by 9.5% sequentially.
The reason for the weak performance is the slowdown in revenues from its parent, the new HP, which accounted for 81% of revenues in 2QFY03. The growth in revenues from its parent has been slowing down for quite sometime now. In 1QFY03, the sequential growth in revenues from the parent was a small 1%. However in 2QFY03, there has been a sequential decline in revenues. Last quarter the company had indicated that the lower growth in revenues from the parent was due to the fact that ‘things are in a state of flux as the parent is sorting out merger related issues’. This seems to be the reason for the decline in revenues in 2QFY03 also. According to the company, due to the HP-Compaq merger, both new deals and renewals were delayed.
(Rs m) | 1QFY03 | 2QFY03 | Change | ||
HP | 711 | 74.0% | 689 | 72.6% | -3.1% |
HP external | 83 | 8.6% | 80 | 8.4% | -3.6% |
Total HP related | 794 | 82.6% | 769 | 81.0% | -3.1% |
Non-HP | 167 | 17.4% | 180 | 19.0% | 7.8% |
Total revenues | 961 | 100.0% | 949 | 100.0% | -1.2% |
However, the growth in revenues from non-HP clients was strong. The company added 21 (28 in 1QFY03) customers for its services business. Thus, the performance of the company has been disappointing due to events that could be temporary in nature. Once the merger related issues are sorted out things could begin to look up for Digital.
Service offerings | 1QFY03 | 2QFY03 | |||
Rs m | % of revenues | Rs m | % of revenues | Change | |
eApplications | 379 | 39.4% | 394 | 41.5% | 4.0% |
Systems Engineering | 185 | 19.3% | 180 | 19.0% | -2.7% |
Enterprise Solutions | 242 | 25.2% | 217 | 22.9% | -10.3% |
eInfrastructure | 104 | 10.8% | 104 | 11.0% | 0.0% |
Telecom | 23 | 2.4% | 27 | 2.8% | 17.4% |
ATG & TSCC* | 8 | 0.8% | 16 | 1.7% | 100.0% |
Products | 20 | 2.1% | 11 | 1.2% | -45.0% |
Total | 961 | 100.0% | 949 | 100.0% | -1.2% |
The decline in revenues from the Systems Engineering could be due to rationalization of platform and technologies at the parent end. Digital traditionally has expertise in Compaq’s technologies. As the parent now consolidates these technologies and completes integration, Digital will have re-align its skill sets to the technologies that will stay. Thus, it could be sometime before revenues from this area show growth. The decline in revenues from the enterprise solutions service offering did most of the damage. However, the lower business was more of a result of the delay in getting new projects as compared to a skill set mismatch. Infact, other IT services firms have shown the strongest growth in this service offering.
At the current market price of Rs 470, the stock is trading at a P/E multiple of 16x its FY03 estimated earnings. In its communication, the company has repeatedly indicated that the parent sees the value in outsourcing to Digital and it’s a question of time before projects start flowing in. Thus, the company expects that 2HFY03 will be stronger than the first half. However, the uncertainty regarding the new parent’s plans for the company and uncertainty over the impact of the merger remains. This is likely to continue haunting valuations in the near future. While the valuations are on the lower side and seem attractive, the element of risk is considerable.
Sorry! There are no related views on news for this company/sector.
My new guide will show you the huge potential in future proof businesses.
The smallcap rally has enough steam left in it. If you haven't joined yet, it is still not too late.
The charts are telling the bulls to be cautious.
Were you shocked that bullion prices hit lower circuits on Friday on the MCX? Find out why it happened...
Ajit Dayal on the investing strategy for 2021 and beyond.
More
Equitymaster requests your view! Post a comment on "Digital: Disappoints". Click here!
Comments are moderated by Equitymaster, in accordance with the Terms of Use, and may not appear
on this article until they have been reviewed and deemed appropriate for posting.
In the meantime, you may want to share this article with your friends!