CYIENT — earnings call
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Prepared remarks
Moderator · Conference Operator
Thank you very much.
We will now begin the question and answer session.
The first question is from the line of Krishna Thakker from Anand Rathi.
Please go ahead.
Mohit Jain
First was on the aerospace side, so you guys have shown confidence on the double digit growth kind of a number.
If you could give some more details on what is happening on the aerospace from a services perspective not from manufacturing perspective.
And second while our growth rate seems to be improving our order intake is still slow for the second quarter and again this is related to services because DLM I think we have done well on the order side, but how should we read these two numbers from an outlook perspective?
Krishna Bodanapu
Thank you for the question.
I will ask Karthik to address this.
Karthik Natarajan
Thanks Krishna I think your observation for Q2 is a seasonal thing and typically Q3 is a strong quarter for order intake so that is what I gave both dollar as well as the constant currency number of 13% because we are still tracking it on the dollar orders today and to answer your first question on aerospace I think we are seeing a lot of opportunities around aftermarket as you would have seen in the last two years with passenger miles slowly checking along which also means many of the aircrafts which have not been taken for service or repair or overall I think they are all coming to what we call them as a more shop visits I think that is really growing by 20%.
So our aftermarket business is definitely very strong and some of the customers were associated with the engine programs that we were doing in for the last eight years I think they are really shaping along well in terms of their demand which is flowing to us.
So that is one change that we have seen.
Second about the embedded and digital solutions that are required for the aerospace and defense I think that continued to be robust because they want to improve the productivity, they want to really try a lot more digital initiatives than what they have done in the past.
We are working with Cyient Limited October 13, 2022 one of the Japanese customers to help them to build a roadmap on industry 4.0 how do they roll out, when they want to grow from x to 4x in terms of production capacity over the next three years and we are involved in helping them to build the roadmap I think that is another example in terms of it we are seeing that kind of growth and another one is about integrating the cabin management with sensors and this will probably improve the comfort level of the passengers and how we think we can probably have a lot more services that can be delivered through the sensors that can be integrated to air cabins.
So some of these opportunities are new we have not seen them before.
I think that is what is driving the growth for us apart from defense which is likely to get stronger as you can imagine in terms of what is happening globally and this is one segment where there is going to be lot more investments that is going to flow in and just to make sure that the country wants to protect their borders and they want to make sure that their citizens are safe and this is going to drive significant growth in Europe as well as in North America on the defence side of the business.
Mohit Jain
The defence part of it how big could that be for aerospace vertical?
Karthik Natarajan
It is probably about less than I would say 15%, 20% of our aerospace business comes from defence and which is likely to see growth as part of what is happening globally.
Mohit Jain
Understood thank you and Ajay Sir on the exceptional item this is like a one-time payout on the legal side or is there something which can come in 3Q and 4Q as well?
Ajay Aggarwal
I think it could continue in Q3 and Q4 as well, but as Krishna said given the face of activities that happened in this quarter we feel that this should be the peak, but it will continue in Q3 and Q4 as well and we will continue to report.
Mohit Jain
In Q4 the quantum is likely to be similar or will it like fade away gradually in Q4?
Ajay Aggarwal
As I said that is what we expect that there is a peak of the activity in terms of preparation but difficult to say right now our senses should go down on Q3 and Q4.
Mohit Jain
On the banker fees this is purely one time done invested in Q2?
Ajay Aggarwal
Yes 100% it is one time done invested in Q2.
Mohit Jain
Perfect thank you.
Krishna Bodanapu
We actually accelerated some of the discovery process because obviously we are also keen to get it done and over with that is why we believe that Q2 is the peak and it will actually Cyient Limited October 13, 2022 normalize quite a bit and we will obviously report it but we are also quite confident that we will be able to manage it.
Krishna Thakker
Just in continuation is there a liability amount which is attached to this case like how big could it be?
Krishna Bodanapu
It is very difficult to say but again I want to be very clear to say that look it is something that we are very confident so we are not taking any provisions or anything because we are confident that what has happened there on the right and we have some very good people advise us and support us multiple times.
Krishna Thakker
Alright Sir, thank you and wish you all the best.
Moderator · Conference Operator
Thank you.
The next question is from the line of Nitin Sharma from Macpro Research.
Please go ahead.
As there is no response from the line we will move to the next question which is from the line of Shradha from Asian Market Securities.
Please go ahead.
Shradha
Congratulations on a good quarter.
Couple of questions firstly what is the normalized margin expectation that we are building in for FY2024?
Krishna Bodanapu
Right now we believe that we will see a little bit of margin improvement but it is not a significant improvement we still are working on that.
We are looking at, at least the base case scenario before obviously we will refine that number and provide you a better insight as things go by.
Right now we are just assuming a slight increase maybe about 50 bps increase in EBIT for next year but obviously there is a lot more work to be done so that can only get better which we will update you as we have better insights but we wanted to get a sense because there is a lot going on and we did not want to leave things in a sort of a limbo so that is why we wanted to provide you at least the base case and then we will refine the base case.
But the margin on this base case because there is some very, very good growth that will come in both organically and also because of these acquisitions giving us the full impact of integration so that is how we have built up so it slowly gets better.
Shradha
The reason I am asking is because Celfinet and Grit are a very high margin businesses and we have indicated that in the first year of integration margins could be lower and probably after the first year integration ideally those margins should be back to their original margin level.
So from that perspective I think FY24 margins can be quite better than what the 16%, 17% normalized EBITDA margin we are talking about for FY2023?
Krishna Bodanapu
You are right so that is why I said we want to work a little bit more before committing definitively.
But also on Celfinet I will say that you are absolutely right the margins are much higher but also the impact is relatively small because of $750 million Celfinet is Cyient Limited October 13, 2022 about $25 million so the impact of that is going to be quite muted in that sense that is why which has been prudent in terms of what calculations we use at least to give you a direction of where next year is.
Shradha
One clarification when you say acquisitions do you also includes the strategic buyout deal that we have called out last quarter?
Krishna Bodanapu
Yes, absolutely again that is also very small that would be less than or it would be a percentage.
Shradha
How is the ramp up which is happening there because this was expected to be one of the top five clients?
Krishna Bodanapu
The ramp up is going quite well actually that has been one of our growth accounts as we have talked about and that will be anticipation, so the ramp up is actually going quite well.
The client or the account for which we did the strategic buyout will actually end up being one of our top 10 customers most likely maybe this year but definitely next year.
Shradha
Just last one question the rail transportation business we have been seeing consistent decline so I was assuming that the offshoring shift that we were seeing in one large account in that business that might have stabilized by now but do you see this offshoring thing is impacting the overall revenue or is it some budget cutting part also that is playing in this vertical?
Karthik Natarajan
I think as I said there are two, three factors one is the consolidation of two of the major companies which is resulting in lesser R&D spend as compared to what they would have done individually and probably they are trying to rationalize where they want to keep some platform where they want to let go off some of the old platforms or legacy platforms they would have had inherited along with them.
Second, there is also a significant infrastructure spend that we talked about and which is likely to be they have a huge order book and they are trying to prioritize the orders they want to execute where they can get some cash flow I think that has been one of the challenges for them from their end customers and that is impacting that and third part what you talked about was offshoring which is definitely true and probably the first two is likely to improve as we start exiting end of this year.
As I talked about the other element was the highest ever billed hours that I talked about in terms of volume.
I think the volume growth is something that we are really happy about and we hope the same momentum continues.
Shradha
Karthik in terms of your optimism on growth for FY2024 amongst the verticals that we are operating do you think aerospace could be driving growth for us in organic business in 2024 because communication growth seems to have tapered off this quarter so maybe on a high Cyient Limited October 13, 2022 base 24 growth numbers for communications might not budge so will it be aerospace or will it be some other vertical doing that heavy lifting for us in 2024?
Krishna Bodanapu
For 24 numbers we will wait for another quarter before getting into the details we are starting a preliminary work because obviously we have put in a lot of resource behind the acquisitions and therefore we did a lot of preliminary work and that is why it gives us the confidence but to get into the details and considering the paucity of calls I believe today is also a very busy day for everybody so I will request that we hold off 24 questions for the next quarter’s call.
Shradha
Thank you Krishna and that is it from my side.
Moderator · Conference Operator
Thank you.
The next question is from the line of Sameer Dosani from ICICI Prudential Asset Management.
Please go ahead.
Sameer Dosani
Thanks for the opportunity.
Few questions one is on telecom vertical we have seen on a Q- on-Q basis until last quarter very good growth momentum so this quarter is it a one-off because commentary suggests that growth momentum will continue.
How do you see this growth?
And second DLM obviously H2 is always better because of the seasonalities do you expect the similar things going forward?
Karthik Natarajan
I think what we have seen for Q2 was one off execution issues that we got into and that is behind us now and we hope we continue to get the momentum for H2 from the communication business and the demand would also be slightly patchy in some customer segments.
So that is what I have seen has not grown as fast as what we have done in the first quarter of this year even for the past three quarters as well.
On your second question on DLM I think we are definitely seeing a better supply chain visibility as compared to what we started off this year and we are confident with the current order book as well as this supply chain visibility I think both are equally critical to see how we improve on our execution for H2.
Sameer Dosani
So we will see that seasonality right improvement in DLM?
Karthik Natarajan
Yes.
Sameer Dosani
Lastly this question is not guidance but a number that you have mentioned $1 billion revenue visibility.
If I look at current numbers and even if I assume that you will reach $1 billion by Q4 FY2024 it gives me around 4% to 4.5% CAGR so how confident are we of that number and does this include and I am assuming that this includes some macro issues also so if you can just explain that?
Cyient Limited October 13, 2022
Krishna Bodanapu
Also I will just quickly say that we are also get one more if I will call it a bump because Citec which will be fully integrated in Q3 so that itself will give us another fairly significant bump because Citec numbers like Ajay said it is only for one month and that has been our biggest acquisition.
But having said that we are quite confident with where things stand even taking into account the macro situation because we have looked up industry-by- industry on what we do and where we stand and how does the macro impact it if you just look at and I just give one example of the semiconductor industry where we are doing a lot of work for the transition of chip manufacturing from China to the US and Europe.
Europe will also announce I think a $50 billion investment into semiconductor plants which will translate to a lot of engineering work for us.
So we are also looking at these things because these industries are also a bit more the reason why a plant is going from China to Europe or the US there is a very strong strategic reason so it is not necessarily just a sort of a nice to have project it is a strategic project and therefore we are quite confident that even of course if the worst case macro situations turn out then that is a different story if Russia drops a nuclear bomb somewhere obviously all bets are off.
But outside of that we are quite confident that even in an environment where we will have some challenges for recession, etc., many of the industries that we are in will do quite okay because again a lot of the work is based on operations of things like power plants which have to continue no matter what are based on things like the transition of the semiconductor industry or like Karthik explained of the aerospace industry and therefore there is a lot of work on operations in MRO therefore we are quite confident in this sort of immediate cases of the macro of course if it is the worst case scenario.
Sameer Dosani
Yes, so I have included two months of Citec $175 million plus $15 million two months impact and if I look at 190 to 250 it is again 4% to 4.5% figure so I get your answer and also just last question on the broader macro right all companies if I look at broader IT services plus all companies are speaking about growth slowdown in Q3 and Q4 and how do you see that impacting your business and in that scenario how does your guidance or outlook changes?
Thanks.
Karthik Natarajan
I think we are still as of now we did not see significant cancellations barring one or two projects which got deferred towards the right.
We are keeping ourselves closely aligned with customers and are definitely looking at the implications of difficult winter in Europe and probably the fed rate hikes in US and how do you think that is going to pan out and what is going to be the implication of it from our customers.
I think we are still seeing a cautious view from our customers.
I think they are looking at the budgets and we will have a better view by end of this quarter which is by December, Jan for us to have a better view for the next year.
We are still confident that at this point of time we are seeing momentum and we want to continue to build up that momentum.
Cyient Limited October 13, 2022
Sameer Dosani
On the deal signing also you do not see any delays or do you see that?
Karthik Natarajan
I think what we are seeing that there are some delays and there are some hiring freezes from customers organically so which means they are open to work with partners and some of those issues have definitely seen but we did not see significant program cuts or there is a major shift in terms of their approach that they are taking for the near-term.
Sameer Dosani
Understood, thanks for the answer good luck for the future.
Moderator · Conference Operator
Thank you.
The next question is from the line of Mihir Manohar from Carnelian Capital.
Please go ahead.
Mihir Manohar
Thanks for giving the opportunity and congratulations on good set of numbers.
I just wanted to understand your thought process behind DLM.
We have decided to separate DLM from this company so what is the thought process that has gone behind it and how are we looking at this business strategically.
Also if you quantify something in number terms how are we looking at this business over the next three to five years, what kind of inquiries are you getting and what is that being the thought process that has got separating it from the company so that was the only question?
Krishna Bodanapu
The idea behind it was as you know the DLM financials and the way the whole business works is very different from the services business and that has brought in a certain degree of uncertainty and it has brought in a certain degree of how our investors are viewing Cyient.
So we took a long hard look at what is the right thing for Cyient and the shareholders side to look at the DLM business and said okay what is the best way to structure it such that Cyient still has a control on the business or as such still good connection to the business because for the reasons that I said we are winning a lot of deals including aerospace project that I talked about because DLM is a part of Cyient.
Design led manufacturing is a very interesting thing, our customers are using us quite a bit for transitions and so it made many things.
So taking everything into account we had a lot of discussions in the Board and we said we wanted to structure it in such a way that it can have its own independence because with all the order books that we talked about and also with what macro was happening there with China Plus One India pervasiveness or prevalence of electronics more and more we are going to grow very well over there.
So we will require capital and we understand that Cyient’s shareholders might not be very happy with us investing significantly in the DLM business and therefore we thought it would be best to separate it out because it will need to raise its own capital for growth.
We are working on our plan where that business can grow about 5x within the next five years with the margins that we already have so it is a very significant growth but also if it requires capital both as you know capex because we will need to build one or two more factories and our customers are also asking us for other Cyient Limited October 13, 2022 options like Vietnam and Mexico and so on and so forth and it will also need working capital because that is a working capital intensive business.
So before that really scales it starts to make very large dents on Cyient’s P&L we thought it was best to structure it separately and really let it grow, I feel really unleash the potential because we are in that spot with the order books that Karthik talked about and we believe in the process Cyient’s shareholders will also benefit generously because there will still be an ownership from Cyient hopefully depending on which option we come up with and over a period of time.
There should be another great source of capital for Cyient to leverage on as we grow the services business, but from a growth perspective about 5x in five years otherwise I would say I would be quite disappointed in that business.
Mihir Manohar
Sure that is really helpful.
If you could throw some more light here on your capital efficiency part also when we look at current numbers on the capital efficiency for this particular segment DLM that does not look encouraging, so how would the capital efficiency pan out and given we are seeing increasing inquiries in India for this part of the business so we are talking about 5x revenue that is really good about how should we as investors see the margins and capital efficiency for this part of the business?
Karthik Natarajan
Absolutely I think as Krishna explained I think one of the constraints we have been dealing with that there is one business which is 15% to 18% potential business is services and there is another business which possibly is 6% to 8% margin business and we are trying to take it to 10% and we put a lot of constraints in terms of what margin business this can be and in fact it goes to 3x, 5x in three, five years.
I think what is important as it will not be a 15% margin business.
It has to be at a very different margin profile and that we turn from the assets have to be much, much higher than what they are so once we have changed those some of those moves to the game and not worry about the dilution of the margin we feel that current ROCE it is about 12-13% we can easily make it to 20% plus and that would be one thing which will be a good reflection of capital efficiency.
Mihir Manohar
Sure that is really helpful.
That is it from my side.
Thank you very much.
Moderator · Conference Operator
Thank you.
Ladies and gentlemen this will be the last question which is from the line of Sandeep Shah from Equirus Securities.
Please go ahead.
Sandeep Shah
Thanks for the opportunity.
Just if I look at the performance of the services business excluding the acquisitions in the first two quarters the first quarter was close to 2.5% this quarter was close to 3% while the implied growth guidance in services on organic basis will be higher than 13%-15% which may require 3% and 4% kind of improve, so just extension to someone’s question in the second half generally seasonally weak for the engineering R&D because of furloughs and the fourth quarter could be a part of IT budgets which may Cyient Limited October 13, 2022 have an impact because of the macro issues.
So how confident are we in terms of good execution in services in the second half as well considering all these factors?
Karthik Natarajan
What I answered earlier I think we continue to see momentum on various sustainability initiatives that we are part of across whether it is mining or energy and other customers that we are associated with I think some of these programs are very long-term and it will be tougher to delay them so they will continue to be there and we are hoping that the communication should start getting back to the growth trajectory like we spoke about and the aerospace would still it is not at the peak that we had in 2020 so we are still hoping that, that should check along.
That is still a long cycle business, and we expect that to continue.
So I think I understand the question of uncertainty and challenges we are likely to see and we would probably have a better view as we close Q3 or early Q4 and we can definitely talk about more with certainty by the time we get to the next call.
Sandeep Shah
Just I missed your one of the comments on the railways of which one of the factor being consolidated entity has been rationalizing the engineering R&D spend second being offshore.
What was the second element on infrastructure which you said because railway growth outlook we were expecting a bounce back in the second half now we expect the bounce back to happen early in the fourth quarter?
Karthik Natarajan
Yes, I think that is led by increase in the interest rates globally and most of them are funded by the government and when they need to pay it at zero or 1% interest rate will be 3% or 5% I think that is going to really have some more prioritization that is likely to happen globally and while if they have four or five programs and which ones they want to prioritize for the near term so that is likely to be the scenario and also given the energy crisis that we are likely to see in Europe and what we are also hearing is they may probably reduce the number of trains that are run.
How do you think they can reduce the number of trips they make in a day and given the challenges that are likely to be seen with the energy being seriously critical for the winter season so I think those are the two, three factors that I talked about.
Sandeep Shah
Just the last question Ajay I think we are building at 13%, 14% with guidance but now we use the word on adjusted basis versus earlier guidance did not use the adjusted basis EBIT margin because at that time also we were knowing there would be M&A related cost which would flow through the EBIT so why there is a change in the guidance for the EBIT margin?
Krishna Bodanapu
We did not know the impact of these numbers and that is why we are looking at the number of the sustainable and ongoing operations because these things are really one-off and that is why we are saying if you take these off because the numbers will also have an impact of the Cyient Limited October 13, 2022 yearly number.
That is why we are saying if we take these off and therefore we can come up with them for whatever the sustainable operation is what is the number and that is why we are saying without taking these one offs.
Sandeep Shah
Thanks and all the best.
Moderator · Conference Operator
Thank you.
Ladies and gentlemen due to time constraint that was the last question for today.
I would now like to hand the conference over to the management for closing comments.
Krishna Bodanapu
Thank you very much and thanks to everybody for taking the time on what I understand is a busy day with a number of calls.
I want to thank everybody for your support in understanding these numbers it has been an exceptional quarter for us, but also we are very, excited that it sets us up for some very exciting growth for the future as we talked about it.
We will continue to engage with you and provide you a good visibility into what that is and how things are going to evolve.
So thank you very much for all your support.
May I again invite you to the investor day it is on November 18, 2022 in Hyderabad.
It will be an all-day session and for those of you who attended our previous investor days you will recall that it will be a good mix of internal presentations on strategy, on operations and financials, but also to show you some of the things that we do and more importantly or most importantly I would say also meet with some of our clients to talk to them about where they see the business going in and Cyient’s place in the business.
So I will send out an invite or has already sent out an invite.
I am sure we will send you multiple reminders so please register for it, it would be a pleasure again to show you with a lot of price what we do in person.
With that thank you very much, thank you for the support and I want to say to everybody that we are very excited where we stand and I think we have a very strong set of quarters coming up.
Moderator · Conference Operator
Thank you.
Ladies and gentlemen on behalf of Cyient Limited that concludes this conference.
Thank you for joining us.
You may now disconnect your lines.
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