While the threat of the global slowdown is real, we believe that Rolta is better positioned than generic IT services peers because of its served market leadership and exposure to less slowdown sensitive end markets.
The company dominates the domestic and export geospatial and plant design services with 70% and 85% market shares respectively.
These strengths have ensured a healthy order book and over 75% earnings visibility for 2Q-4Q09 even with three quarters to go.
Rolta’s end markets are being driven by IT infrastructure upgrades by the Indian defence, the need for intelligent maps by utilities and governments, design requirements for domestic power and refinery build outs, and increased design services offshoring.
The company is differentiated from generic Indian IT services players from: 1) limited competition in differentiated served markets that enables strong revenue growth, 2) domestic defensive sector growth from long-term projects that are in the early design stages and hence less prone to near-term financing issues, and 3) strong demand as indicated by realization gains even as generic peers struggle to hold on to pricing.
Rolta is part of two high potential JVs- one with Thales which could expand its defence target market from the currently $40 million to over $600 million, and two with Stone and Webster, which allows the company to participate in a potentially $5 billion - 5.5 billion nuclear design opportunity that the recent India-US deal has opened up.
The company has made key acquisitions and management additions recently that further extend its long-term prospects.
Our target price of Rs220 is based on a DCF methodology (WACC of 14.8%, terminal growth of 5%). We assume a 10-year revenue CAGR of 18% and an average annual EBIT margin drop of 40bp.
The target price implies a 9.9x FY10E P/E, on an FY08-11E EPS CAGR of 21.9%, and is more than one-standard deviation below the one-year forward historical mean. The key risk to our thesis is an adverse impact on orders due to a difficult macro environment.