Company background: L&T Technology Services Limited (LTTS) is subsidiary of Engineering giant, L&T and was incorporated in Jun-2012. Post transfer of Product Engineering Services (PES) and Integrated Engineering Services (IES) division and 2 acquisitions in 2014-15, LTTS emerged as leading pure play Engineering Research & Development (ER&D) player. Zinnov recognizes LTTS in "leadership zone" in 8 Industry verticals (Industrial Automation, Construction and Heavy Machinery, Medical Devices, Aerospace, Automotive, Rail and Marine, Telecom, Energy and Utilities) & 2 horizontal offerings (Embedded Systems and Mechanical). LTTS has 12 Global Delivery Centres (GDCs), 27 sales offices globally and 31 Labs in India. As of Jun-2016, LTTS has 9,419 Engineers from 9 nationalities serving 200+ customers, including >50 of Fortune 500 customers.
Positives: (1) LTTS, a leading global pure-play ER&D company is likely to benefit from (a) under-penetration, (b) expected increase in India's market share in outsourced ER&D space, and (c) strong 13% industry CAGR during FY2015-20E, (2) pursue multi-pronged growth strategy, which includes (a) Focus on key Segments, Verticals and Geographies, (b) mine existing customers and add new customers, (c) Focus on Solutions-oriented Engineering services, (d) continued investment towards innovation labs, (e) pursue selective acquisitions, (f) Attract and retain employees, and (3) Operational levers (improvement in Utilization, better onshore-offshore mix) to aid margin expansion, and (4) strong historical financial performance.
Risks & Concerns: (1) LTTS could lose business volumes if large clients set-up their own captive R&D centers, (2) LTTS is dependent to large extent on limited clients. Loss of a major client could impact the revenues of LTTS.
Valuation: LTTS trades at 21.0x FY2016 EPS at upper-end of issue price band. On considering (1) strong growth potential of LTTS, which is ahead of some of the industry peers, coupled with (2) 38%+ RoE levels in FY2016, (3) FY2015-16 average cash flow from operations of Rs. 446cr, (4) strong ~64% dividend payout (translating to ~4% dividend yield), we are of view that LTTS stock has the potential to trade at premium to the peers. However, if we consider the average of the 3 peers, then LTTS stock has been priced at 19% discount. Given that the LTTS IPO has been priced at discount, we advise SUBSCRIBE.