Stock Pick from IT Consulting & Software

CHOICE SCRIP

Here Is Why:

• Focus on margin expansion to improve profitability.

• Strong balance-sheet with net cash of Rs 53.41 crore as on H1 FY15.

• Focused in the areas of e-commerce, social mobility, and DRP.

Sonata Software: A PROFITABLE BYTE

With its network of computing services spread wide across both domestic and international territories, the company is moving ahead at a brisk trot

This time we are focusing on a mid-sized IT services company where we have already seen a turnaround in its financial performance. Along with higher growth in revenue, the company’s margin too has improved in the past four quarters. Its business traction is expected to continue, given its efforts to strengthen the sales force in global markets and rationalize operating expenditure.

Sonata Software is a global IT services company headquartered in Bangalore with presence across major markets such as the US, UK, Europe, APAC and the Middle East. The company operates in two major business units - international IT services (34.5 per cent of revenue) and domestic products (65.5 per cent of revenue). The former segment is a high-margin segment while the latter is a low-margin segment and going forward the management expects to bring down the overall contribution of domestic products in its total revenue.

The company’s international IT business focuses mainly on travel, retail, CPG and offshore product engineering. The company has around 18 Fortune 500 clients and has managed to grow with these accounts. Its international IT services’ revenue grew by 9 per cent CAGR in the period FY10-13; however during FY14 and 9M FY15 the company improved its performance and delivered 45 and 27 per cent revenue growth in rupee term respectively. The EBIDTA margins of IT services have also shown substantial improvement mainly due to strong growth and currency tailwinds.

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For FY14 the IT services’ EBIDTA margin stood at 17.5 per cent, up by 640 bps over two years. The IT services’ 9M FY15 EBIDTA margin stood at around 25.2 per cent. Even if we exclude a couple of percentage gains from currency volatility, this segment has maintained a margin of more than 22 per cent, which looks sustainable and will help to improve the overall margin as contribution from this segment improves in the total revenue of company.

Sonata Software, through its subsidiary Sonata Information Technology, is engaged in distribution of packaged software products in India. This business caters to enterprises in the domestic market. In FY14 the revenue from its domestic products increased by 10.9 per cent to Rs 1,085 crore, with 100 bps EBITDA margin expansion to 3.2 per cent. In 9M FY15 the revenue dipped by 2 per cent YoY to Rs 858.6 crore with margin of 3.1 per cent - up from 2.3 per cent in 9M FY14 after adjusting for interest income received on an income tax refund.

On the valuation front, Sonata Software is trading at TTM PE ratio of 14.75x with EPS of Rs 11.65. We recommend our readers to take an exposure in the stock with expectation of 35-40 per cent gain from its CMP in the next one year due to encouraging growth outlook coupled with comfort valuations.