Buy Sonata Software; target of Rs 395: HDFC Securities

HDFC Securities' research report on Sonata Software

International IT services (IITS) revenue increased 2.3% QoQ (+3.0% CC) to USD 45.3mn vs. est. of USD 45.2mn. Growth was led by IP-led (24.2% of rev, +5.0% QoQ) and will remain the key growth driver. Sonata has invested in the Microsoft relationship which has yielded results, Dynamics 365 has grown at 8qtr CQGR of 6.9%. The next phase of growth will come from entry into other growth areas (Data & Cloud) within Microsoft account. IITS margin stood at 22.0% down 24bps QoQ slightly below est. of 22.5%. Margin was impacted due to muted performance of acquired entity (Sopris) offset by higher utilisation (+180bps QoQ). We expect gradual expansion in IITS margin led by IP-led, desired range is 22-24%, higher than peers. Total Revenue was down 19.6% QoQ to Rs 7.03bn due to 30.5% QoQ decline in Domestic Product & Services (DPS) revenue. DPS performance is measured on absolute EBITDA (Rs 0.23bn, +0.4/27.1% QoQ/YoY). IP-led and Digital (37% of rev) grew by 55.8/22.5% YoY. ~65% of the incremental growth is coming from IP-led revenue (higher margin). Receivable was down to Rs 7.12bn in 1HFY20 vs Rs 8.11bn in FY19, but still has increased substantially in the last two years. Domestic slowdown is impacting DPS collections, which is a concern.

Outlook

We maintain BUY on Sonata based on inline revenue but slight miss on margins in 2QFY20. IP-led strategy is driving IITS growth (+9.1% 8qtr CQGR) and is aiding margin expansion (+133 bps YoY). We downgrade P/E multiple to 12x from 14x to factor in rising receivables in the DPS business. Our TP of Rs 395 is based on 12x Sep-21E EPS.