KPIT Cummins Infosystems Ltd reported strong double-digit revenue growth for the third consecutive quarter. Revenue grew by 12.6% in the March quarter compared with the December quarter.

For a change, the firm’s operating profit, too, grew in double digits on a sequential basis. In the preceding two quarters, profit had risen by 6-7% because of a drop in margins.

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The March quarter also happened to be the first one in fiscal 2010-11 (FY11) in which the company’s operating profit rose on a year-on-year (y-o-y) basis. In the first three quarters of the fiscal, while revenue grew by 34% y-o-y, profit fell by 11% because of a sharp contraction in margins.

Despite this apparent improvement in profitability, investors weren’t excited. The company’s shares fell marginally in a flat market on Tuesday.

While it’s heartening to note that KPIT Cummins’ margins didn’t fall last quarter like they did in the preceding quarters, the fact that margins didn’t improve from already low levels was a disappointment. To be sure, after the December quarter results, the company had said that it expects margins to improve by 100-150 basis points in the March quarter, according to a Reuters report. One basis point is one-hundredth of a percentage point.

Instead, Ebitda (earnings before interest, tax, depreciation and amortization) margins remained at the December quarter level of 14%, a whopping 800 basis points reduction compared with margins in FY10. For the year as a whole, margins fell by over 700 basis points. So, even though revenue grew by 40% in the last fiscal, Ebitda fell by 6%.

KPIT Cummins’ experience isn’t very different compared with most mid-cap information technology firms, which are struggling with high attrition and the resultant need to increase compensation. High attrition also results in lower employee utilization levels, which hurt margins.

KPIT Cummins’ problems were compounded last year because of its decision to hire a large number of freshers, who underwent extensive training and, hence, weren’t billable for some time. Its utilization rates fell by about 300 basis points to 68.5% last year.

Yet, even while margin performance was disappointing, the company kept investors happy by delivering strong revenue growth. While acquisitions contributed to the revenue growth last year, organic growth, too, was strong at around 35%.

Growth was led by the SAP (system application and products) business, which grew by 66% on an adjusted basis. This was followed by the automotive and engineering segment, which grew by over 41%. Revenue from the company’s largest client, Cummins Inc., grew by only 5.6%, while the non-Cummins business grew by as much as 54.6%, which is a healthy trend since it diversifies the company’s revenue base.

The company now expects revenue to grow by 22-27% in FY12, which is much higher than Nasscom’s growth estimates for the industry. But there are headwinds such as high attrition on the margin front. Even so, as Prabhudas Lilladher Pvt. Ltd notes in a results update, the stock already factors in expectations of strong earnings momentum along with margin improvement.

Graphic by Sandeep Bhatnagar/Mint

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