Valuation concerns limit upsides for L&T Tech and Tata Elxsi stocks

The stock of L&T Technology Services (LTTS) was among the top losers on the BSE 100 Index, shedding 4.9 per cent in trade on Wednesday. While the software major, which offers engineering, research and development (ER&D) services to companies, posted a healthy July-September quarter (second quarter, or Q2) performance, worries of a potential slowdown and punchy valuations weighed on the stock price. At the current price, the stock is trading at 29x its 2023-24 (FY24) earnings estimates.

Although HDFC Securities expects the company to log an earnings per share growth of 19 per cent over 2021-22 through 2024-25, it believes the upside potential for the stock is limited.

Other stocks in the ER&D space also came under pressure due to weak operational performance.  While revenue growth for Cyient came in below Street estimates, Tata Elxsi disappointed due to muted margin performance. Tata Elxsi is down about 13 per cent from its results, while Cyient is down about 2.4 per cent.

The near-term triggers for the stocks in the ER&D space are the Q2 performance and the growth guidance/outlook for 2022-23 (FY23).

LTTS reported a 3.2 per cent sequential revenue growth — slightly lower than estimates. The growth was led by the transportation and plant engineering verticals.

Transportation is by far the largest vertical for LTTS and accounted for 34.5 per cent of the company’s overall revenue in the quarter. The revenue miss in the quarter was on account of a weak showing in telecommunications and high-technology (or advanced technology) which reported sequential revenue fall of over 1 per cent — the vertical contributes a fifth to sales.

After record bookings in the April-June quarter, deal wins have remained healthy in Q2, while pipeline, too, remains robust. The constant currency revenue growth guidance for FY23 was increased to 15.5-16.5 per cent, compared to the earlier 14.5-16.5 per cent, which, according to analysts Mukul Garg and Raj Prakash Bhanushali of Motilal Oswal Research, is a positive, given the challenging macro environment.

Cyient also disappointed on the revenue front, with 8 per cent year-on-year (YoY) organic growth.

Anand Rathi Research says at $151 million (flat sequential revenue show), Cyient’s services business grew slower in Q2 than its 8-11 per cent YoY range for the past four quarters, while LTTS trajectory stood at 13-18 per cent YoY. The company maintained its FY23 organic revenue growth guidance at 13-15 per cent in constant currency terms.

Motilal Oswal Research is sceptical of the company meeting its revenue outlook (revenue run-rate of $1 billion) for FY24.

Tata Elxsi’s revenue performance remained healthy, with rupee revenue growth at 4.7 per cent led by transportation and health care verticals also driving the order book and deal pipeline.

Deal ramp-ups offer visibility over the next few quarters. The margins, however, slipped sharply on a sequential basis due to higher employee costs, other expenses, and depreciation.

Margin expansion earlier was led by stretched operating metrics of utilisation, cost savings, and offshore — some of which have reversed, says Akshay Ramani of Axis Capital.

Commenting on the growth outlook, Kawaljeet Saluja and Sathishkumar S of Kotak Institutional Equities say a slowdown/recessionary scenario is a high probability in the US and in Europe from an ER&D standpoint, given the deteriorating macro. Such situations usually lead to a cut or optimisation in R&D programmes and impact third-party partners.

The high-technology sector is already impacted. Asset-heavy verticals of industrial products can follow through, together with some sub-segments in plant engineering, they add.

Given valuation concerns, most brokerages believe the upside is limited in LTTS and Tata Elxsi, while there is value in Cyient.