The key positives for Intellect are: 1) software products catering to BFSI that is one of the largest spenders in IT services & software, 2) improving quality of revenues (licence + AMC as percentage of revenues has increased from 36% in FY17 to 46% in FY20), 3) improving margin trajectory led by cost rationalisation (cost is now aligned to non-licence revenue stream), 4) focus on lowering debtor days thereby reducing working capital requirement. In addition, the company has a healthy order backlog of Rs. 1156 crore, a strong deal funnel (~Rs. 4020 core) and a digital-ready product portfolio that provides confidence on improved revenue trajectory in coming years. Further, the company has aligned its cost structure with sustainable revenues, which we believe will reduce volatility in margins (one of the key concerns in product companies) and improve cash flows. We believe this will be key to a sustained re-rating of the stock.
Huge addressable market, healthy deal pipeline key growth drivers
All the company's software products are catering to the BFSI vertical. Banks and financial institutions are believed to spend about 7-8% of revenue on IT of which 20% is allocated to buying new software or upgrading existing software. However, considering that only ~18-20% of the IT software budget is outsourced, it represents tremendous potential for growth in coming years. This, coupled with a healthy order backlog of Rs. 1156 crore (book to bill of 0.85x), strong deal funnel (~Rs. 4020 core), digital-ready product portfolio, focus on large deal wins, improving iGCB (retail banking focused software product) revenues would help the company to register double digit revenues (~10%) in the longer term (in line with three year CAGR of dollar revenues, which was 11.9%).
Tight cost control leading to profitable business model
The company's focus on improving annuity revenues, reducing employees (~500 in past 12 months), tighter R&D spend (due to product maturity) and rationalisation of SG&A expenses has led to ~20% EBITDA margins in Q1FY21. Intellect has also aligned its cost to non-licence revenues (i.e. AMC + Cloud + implementation revenues is equal to operating cost), which means the company would continue to report healthy margins in coming quarters led by improving licence revenues. This coupled with expanding scale of operations would enable Intellect to sustain ~19% margins in the longer term.
Focus on cash generation
The company has historically seen higher debtor days that has led to high working capital requirement and even equity dilution. However, Intellect has now modified its incentive structure to improve collections. The same is visible in Q1FY21 results (debtor days is down to 126 days from 150 days). Lower working capital requirement, improving margins may boost operating cashflow and help the company significantly deleverage its balance sheet.
Valuation & Outlook
Healthy orderbook, huge addressable & underpenetrated market, improved annuity revenues, cost rationalisation are expected to keep revenue, margin upbeat. Also, improved cash flow (due to lower working capital requirement) may led to de-levered balance sheet, no equity dilution. Hence, we assign a BUY rating to the stock with a target price of Rs. 260/share i.e. 2.6x FY20 EV/Sales (~50% discount to Majesco's valuation of 5x EV/sales as Intellect needs to show consistent margins, debtor days for further re-rating).
For details, click on the link below: https://www.icicidirect.com/mailimages/IDirectinstinct_IntellectDesignArena_Sep20.pdf
Shares of Intellect Design Arena Ltd was last trading in BSE at Rs.215.7 as compared to the previous close of Rs. 208.6. The total number of shares traded during the day was 93772 in over 1875 trades.
The stock hit an intraday high of Rs. 219 and intraday low of 201.8. The net turnover during the day was Rs. 20347819.