Demand is robust but supply-side constraints due to new variant – Sonata Software

Demand is robust but supply-side constraints due to new variant – Sonata Software

Update on the Indian Equity Market:

On Wednesday, the benchmark index NIFTY 50 closed at 16,955 (+1.1%), 185 points higher. Among the sectoral indices, REALTY (+3.0%), PHARMA (+2.0%), and METAL (+1.8%) led the gainers. None of the sectoral indices ended with losses. Among the NIFTY50 components, HINDALCO (+4%), TATAMOTORS (+3.7%), and DIVISLAB (+3.5%) were the top gainers while SBILIFE (-1%), WIPRO (-0.7%), and GRASIM (-0.4%) led the laggards.

Excerpts of an interview with Mr. Jagannathan Chakravarthi, CFO of Sonata Software with CNBC-TV18 on 20th December 2021:

  • Chakravarthi said they did not see any impact on demand due to the omicron variant and they also don’t expect any impact. Due to omicron, they expect there will be some supply-side constraints but the company has taken initiatives to mitigate the risk like diversified delivery centers in various locations globally. The pipeline is very strong and company expects the demand continues for the next 8 to 12 quarters.
  • On working from the office Mr. Chakravarthi said, they are not very clear about working from the office. The large players have started the process but Sonata exploring and evaluating possibilities of how much workforce will work from home for now and they said the company is not going back to an earlier stage of 100% work from home. The industry is in the wait and watch kind of situation and the company will decide after some clarity comes on omicron and its impact.
  • In the shorter term, there will be some cost pressure. The salary increases, retention bonus, and salary increment cycle are likely to put pressure on cost. 3QFY22 is expected to be a little moderate in terms of attrition for the overall industry but the company will look at how 4QFY22 and 1QFY23E are coming out in terms of attrition and cost pressure. The impact of cost increases is expected for one or two quarters and margins will not substantially be affected because of that.
  • On client addition, he said there is no pressure on new client addition. Company qualifying the clients according to their qualifying mechanism and prioritizing the clients because the demand is huge. The company is at high levels of utilization and it has to match up with supply-side also.
  • Sonata Software is at EBITDA levels of 27% to 28% which is an industry-leading margin. The company expects if the changes happen in the business for the medium term they will continue to maintain a 23% to 25% EBITDA level for a longer run.
  • The company expects demand to continue to be robust and the company will be at an industry-leading growth rate. It’s hiring has been strong for the last 2 quarters and the company is now well prepared for omicron compared to the delta variant.

Asset Multiplier Comments

  • We think Sonata Software will be able to add more clients as they have strong hiring plans and are investing in senior talent to meet the strong demand momentum. This is likely to drive the growth of the company in the longer run. The hiring also controls the attrition rate and utilization levels.
  • Share of digital revenue has been continuously improving from the last few quarters in International IT Services (IITS). We think a higher share from digital revenue drives the higher margins in IITS. Healthy traction in Retail, Commodity and travel segment we expect strong revenue growth in going forward.

Consensus Estimate: (Source: market screener website)

  • The closing price of Sonata software was ₹ 814/- as of 22-December-2021. It traded at 25x/20x/18x the EPS estimates of ₹ 32.4/41.5/46.5/- for FY22E/FY23E/FY24E respectively.
  • The consensus target price of ₹ 964/- implies a P/E Multiple of 23x on FY23 EPS estimate of ₹ 41.5/-.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”

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