KPIT Cummins offers a good long-term opportunity for investors

KPIT Cummins has managed to beat the street expectations in the second quarter of 2012-13, much as in the previous quarters. Its revenue in the US dollars has gone up by 5.5% compared with that in the previous quarter. KPIT Cummins achieved this due to the improved performance by the recently acquired company, Systime, which reported a quarter-over-quarter (q-o-q) revenue growth of 15.7%.

Though KPIT Cummins’ q-o-q revenue growth rate is less, Cummins continues to be its top client and contributed around 19.5% to its revenue in the second quarter. However, KPIT Cummins’ effort to broadbase its client base and generate higher growth from other top clients are yielding fruit. The company has increased its total active client base from 172 in the first quarter to 176 in the second. Its revenue from top 10 clients, excluding Cummins, also reported a growth of 8% q-o-q.

More importantly, KPIT Cummins improved its EBITDA margin to 16.7%, a growth of 157 basis points compared with that in the previous quarter. Several factors, such as an improvement in operational efficiency, better leverage of sales and general administration expenses due to increased sales, increased share from automotive segment that offers a better margin, contributed to this.


However, the net profit for the quarter came down on a q-o-q basis because of the forex-related losses (Rs 21.3 crore loss compared with a small gain of Rs 1.8 crore in the first quarter), and an increase in tax rates (29.4% in the second quarter compared with 25.7% in the first).

Outlook & valuation: Despite the high base effect (KPIT has grown by nearly 40% in 2011-12), the management has maintained the 2012-13 US dollar revenue growth rate at 32%-35%. Though the high growth is partially due to the acquisition of Systime, it is one of the highest among its peers and is about 2.5 times the Nasscom estimate. With high growth rates seen in the first half of 2012-13, analysts are hopeful that the management will revise its guidance upwards after the third quarter results in January.

However, the market has not given a higher valuation to KPIT Cummins because it has a net debt of Rs 53 crore on the balance sheet. Another reason for this low valuation is the earnout payable on its acquisitions, which will limit the generation of free cash flow. KPIT Cummins has to make an earnout payment of around $20 million for the second half of 2012-13.

However, investors should note that an earnout payment structure helps the acquirer (KPIT Cummins, in this case) by linking the payments to certain targets achieved by the acquired company.

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