Best midcap IT stock: Tata Elxsi vs KPIT Technologies

With the swift rise of digital transformation, the engineering research and development (ER&D) industry continues to thrive as companies embrace digital trends.

ER&D is the process of turning ideas into tangible products, services, and processes.

Now, this segment is evolving from just design and deployment to include maintenance, regular updates, and continuous data analytics.

This has extended the product life cycle significantly, offering monetization opportunities for product companies. It has also expanded business prospects for ER&D firms.

In this rapidly evolving landscape, India assumes a pivotal role, positioned at the forefront of technological innovation and disruption.

It emerges as a prominent global hub for ER&D, leveraging its abundant talent pool and competitive cost structure to gain a significant foothold in the industry.

According to NASSCOM, revenue from ER&D in India is projected to reach US$ 41 billion (bn) by 2023. This will be driven by a steady increase in digital ER&D spending. This trend highlights the scope for growth in this sector in the years to come.

Bearing this in mind, we compare two players in this space - KPIT Tech and Tata Elxsi.

Background

Tata Elxsi

Tata Elxsi is amongst the world’s leading providers of design & tech services across industries.

It’s operations can be classified into two business divisions, i.e., software development and services and systems integration and support.

The software development and services (accounting for 87% of total revenues in the financial year 2023) division is the most significant business component, comprising 3 focus verticals: transportation (37.4%), media & communications (36.1%), and healthcare (13.5%).

The system integration and support services (13% of total revenue) are an important component of the company’s end-to-end product life cycle services – right from conceptualisation to maintenance services.

The key customers of the system integration and support division are from the manufacturing, aerospace, government, education, automotive, and information technology firms.

The primary markets for Tata Elxsi are the developed economies of the US, mainland Europe, Japan and Asia Pacific, with the US contributing 42.5% to the total revenue in the financial year 2023, Europe 34.4%, and India 17.0%.

KPIT Technologies

KPIT is a global technology company catering to the automotive and mobility ecosystem, making software-defined vehicles a reality.

Over the years, it has developed into a leading automotive software provider in embedded automotive software.

The primary markets for KPIT Tech are the developed economies as well, with Europe leading the pack (51.8% of total revenues), followed by the US (29.8%), and Asia (18.4%).

Revenue Growth

KPIT Tech has clocked in higher revenue growth over the last four years. Its 4-year-CAGR stands at 48.7% whereas, Tata Elxsi’s stands at 18.4%.

KPIT Tech caters to the transportation segment alone. Within this, the passenger cars (82% of total revenue in the financial year 2023) and commercial vehicles (balance 18%) segment both have grown at a healthy pace, contributing strongly to revenue growth.

Unlike KPIT Tech, Tata Elxsi’s performance is based on transportation, healthcare, and media. While transportation and healthcare have been growing at a healthy pace, the media vertical has been lagging behind.

Online media streaming companies face profitability challenges due to the rising costs of acquiring and producing content, coupled with the fragmentation of the streaming market. Generating revenue through advertising in this fragmented landscape is challenging.

Profitability

A company's profitability is best reflected in its operating margin, which is the operating profit (earnings before interest depreciation tax - EBIDTA) divided by earnings.

Simply put, it measures how much profit a company makes on one rupee of sales from its core operations (before interest and depreciation).

A higher operating margin is usually a result of two things - either the company is generating higher revenues or is keeping a tight lid on its costs.

Tata Elxsi’s operating margins have been consistently higher and have grown at a faster rate than KPIT Tech’s.

Tata Elxsi has reported an average margin of 30.1% over the last five years, whereas KPIT Tech margins averages out to be 19.1% over the same period.

Revenue Per Employee & Attrition

For IT companies, employees are undoubtedly their biggest assets.

The revenue of IT companies is directly proportional to the efficiency of their employees. The more efficient employees are, the more revenue a company would make given that they are able to win projects.

Revenue per employee represents how much money a company makes on one employee. In a way, it is a measure of an employee's efficiency.

Another employee-related metric that is of paramount importance for IT companies is the attrition rate. This reflects the number of employees leaving the organisation with respect to the employees working in the company.

Let's see how Tata Elxsi and KPIT Tech perform on these crucial parameters.

For the year ended March 2023, Tata Elxsi and KPIT Tech had a total headcount of 11,864 and 10,297 employees, respectively.

Based on these numbers, Tata Elxsi's revenue per employee turns out to be ₹2.7 m which is a little lower than ₹3.3 m KPIT Tech makes on every employee.

It seems that either KPIT Tech employees are more efficient, or the company negotiates better terms with its clients for every employee it deploys on the project.

On the attrition front as well, KPIT Tech does a better job than Tata Elxsi.

In the financial year 2023, Tata Elxsi reported an attrition rate of 17.3%. For the same year, KPIT Tech’s attrition stood at 15%.

Dividend

Dividend measures the additional income an investor can make, other than the appreciation in the value of the share. The higher the ratio, the better the return for the shareholders.

Most mature IT companies generate a lot of cash as the capital expenditure to grow is minimal. And so they tend to be dividend paymasters.

The five-year average dividend yield is a little different for both companies with Tata Elxsi’s being higher at 1.5% compared to KPIT Tech’s at 0.9%.

However, both Tata Elxsi and KPIT Tech’s dividend yield is lower than the current industry average of 2.12%.

Return on Equity

Return on equity (RoE) is one of the most meaningful indicators of a company's profitability and efficiency.

An excellent tool for analysing the returns of a company, it tells you the amount of money a company can generate on the shareholder capital invested (shareholders equity).

The 5-year average for KPIT Tech stands at 17.6%, far lower than Tata Elxsi’s which stands at 33.6%.

However, the number for KPIT Tech seems to be moving up, following the uptick in profitability (indicated by the operating margin).

A higher number indicates that KPIT Tech is generating more returns by employing its capital efficiently.

Valuation

The most common and effective ratio for comparative analysis and valuation is the price to earnings (PE) ratio.

The PE ratio uses the company's earnings to find the value a shareholder is willing to pay for one rupee of earnings.

The PE ratio for Tata Elxsi currently stands at 55.7. This is close to its 5-year average of 58.9. This indicates the stock is fairly valued. However, it is trading much higher than the current industry PE of 28.5.

The PE ratio for KPIT Tech is 70.5, which is much higher than its 5-year average of 51.7 and the current industry PE of 28.5. This indicates the stock is overvalued.

Bright Prospects

Automakers are eyeing substantial revenue from software-enabled services, particularly with the rise of electric vehicles (EVs) and autonomous vehicles (AVs).

By 2030, the global automotive software and electrical and electronic components (E/E) market is projected to hit US$ 462 bn, growing at 5.5% annually.

This growth is driven by the increasing demand for advanced driver-assistance systems (ADAS) and autonomous driving (AD) sensors, particularly LiDAR, cameras, and radars.

Original equipment manufacturers (OEMs) are focusing on software content to enhance vehicle capabilities and profitability.

Research and development (R&D) investment is surging in vehicle software implementation to offer personalised digital experiences and generate new revenue streams.

The industry is transitioning to centralized E/E architecture, leading to a rise in demand for software, especially for electric vehicles (EVs) and premium comfort features.

Major investments are directed towards connected, autonomous, shared, and electric (CASE) technologies and architectural changes for self-driving vehicles.

By 2030, automotive software spending is anticipated to reach US$ 43 bn.

The global healthcare sector is rapidly embracing digitalisation, with digital healthcare and diagnostics leading the way. This shift offers cost control, market expansion, and the integration of AI for enhanced data and image analysis.

Tata Elxsi or KPIT Tech: Which is Better?

With a strong outlook and solid fundamentals in place, the long-term view of Tata Elxsi and KPIT Tech seems bright.

While KPIT Tech’s revenue growth is two times that of Tata Elxsi’s, Tata Elxsi’s margins are higher. This makes it a stronger and more efficient player in comparison to KPIT Tech.

Stronger margins has led to higher RoEs for Tata Elxsi, giving investors more bang for their buck.

Moreover, while KPIT is a pure-play automotive design led company, Tata Elxsi enjoys relatively diversified revenue base catering to automotive, healthcare, and media sectors.

However, both companies enjoy large-scale operations and established presence across geographies.

From a valuation perspective, the shares of KPIT Tech are trading at a premium to the shares of Tata Elxsi.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com