Sonata posted a weak quarter; the fall in IT services (IITS) revenue (-19.6% QoQ organic) was higher-than-estimated, but margin expansion of 104bps QoQ came as a positive surprise. The impact on IITS was due to an issue in one large travel client (down ~80% QoQ); ex-travel, its revenue was up 1.2% sequentially. Sonata has invested in strengthening the Microsoft relationship, which has yielded positive results (4Y CAGR of 19%). Dynamics D365 related services (34% of revenue) has grown at an eight-quarter CQGR of 7.8%. Furthermore, the margin expansion in IITS was led by a reduction in cost, offshoring and higher IP-Led revenue. The IITS margin will be maintained in the range of 21-22%. DPS growth was strong (+12.2% QoQ), but higher discounts impacted margins. Higher cloud license sales should lead to growth in DPS, but discounts could impact profitability. We like Sonata’s IP-led business model, highest margin (IITS) in Tier-2 IT, focus on high growth Microsoft ecosystem, healthy RoE (~38%), and high dividend yield (~5%). We cut our EPS estimate by 2.3/6.2% to factor in the near-term growth challenges and lower DPS margin.
OutlookThe stock is trading at a P/E of 13/11x FY21/22E, in line with the five-year average multiple. We increase our target multiple to 12x (vs. 11x) to arrive at a target price of Rs 320, based on June-22E EPS.
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