Cyient - Motilal Oswal Group · in several projects, and new opportunities bearing fruit. With this and several other levers, we also expect margins to expand by 0bp over FY16-18

Sagar Lele ([email protected]); +91 22 3982 5585

Three knots ahead

Cyient

Initiating Coverage | 15 February 2016 Sector: Technology

Ashish Chopra ([email protected]); +91 22 3982 5424

Cyient

15 February 2016 2

Cyient: Three knots ahead

Summary .................................................................................................................... 3

Story in charts ............................................................................................................ 5

Leadership in the high-growth Engineering Services segment ................................ 7

Larger, stickier and more important ....................................................................... 12

All-time high orderbooks in Aerospace… ............................................................... 15

Increasing fleet of aircrafts to lead to MRO boom ................................................ 19

Inclusion of services as eligible offsets, a big positive ........................................... 23

Expect revival in performance going ahead ........................................................... 26

Initiate coverage with a Buy; TP of INR550 ............................................................ 31

Company description .............................................................................................. 34

Key management personnel ................................................................................... 35

Key risks ................................................................................................................... 37

Financials and valuations ........................................................................................ 39

Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.

Cyient

15 February 2016 3

Three knots ahead Multi-year growth opportunities in Manufacturing, MRO and Defense

Cyient (CYL) is a market leader in Engineering Services in the Aerospace andRailways verticals, which constitute to 50% of its total revenue. Its relationships with marquee clients, years of experience, and partnering with customers in critical parts of their development programs have helped CYL sustain its leadership position.

To further boost its positioning, CYL is geared to tap the potential in three areasthat are all at the cusp of a multi-year growth trajectory: [1] ElectronicManufacturing Services, [2] MRO, and [3] Defense. Together, these three areasincrease its addressable market by ~12x (from USD1b in Aerospace EngineeringOutsourcing to USD12.3b in the three additional areas).

This should help turn around growth performance going ahead, following twoyears of subdued numbers caused by client-specific headwinds. In USD terms, weestimate 12% revenue CAGR and 14% earnings CAGR over FY16-18.

With most issues behind and likely thrust from new areas, we expect the stock tore-rate from the current 9x FY18E earnings. Our 1-year price target of INR550discounts forward earnings by 13x.

Leader in Outsourced Engineering Services in Aerospace and Railways CYL is a major Engineering Services player (65% of revenue), with leadership

in the Aerospace and Railways verticals. It also provides Engineering Servicesin verticals like Semiconductors and Off-highway Products. 35% of itsrevenue comes from Data Transformation, Network & Operations (DNO) forCommunication Service Providers and Utilities.

CYL has been consistently rated in the leadership zone for Aerospace,Railways, Construction, Heavy Machinery and Energy segments by variousrating agencies. It is the largest player in Aerospace and Railway EngineeringOutsourcing, with a market share of 60-70%.

While major commercial aerospace development programs are entering alow cycle, we expect activity to continue for a couple of years given [1]ongoing programs like Boeing 787-10 and Boeing 777X, and [2] continualtechnological advancement in aircraft and engine enhancement.

The outlook for Railways appears positive, with higher incremental spend inrolling stock and signaling (the areas CYL is present in). Having worked with7 of the top 10 OEMs and having delivered over 200 major global projects,CYL continues seeing strong traction. This will get a further boost in FY17, asit commences work in its East European delivery center.

Focused on fastest growing segment in India’s exports as per Nasscom According to Nasscom, the Engineering Services segment is the fastest

growing among outsourced services (15% CAGR over last six years v/s 13% for total exports).

Initiating Coverage | Sector: Technology

Cyient CMP: INR393 TP: INR550 (+40%) Buy BSE Sensex S&P CNX

22,986 6,981

Stock Info Bloomberg CYL IN Equity Shares (m) 112.2 52-Week Range (INR) 641/385 1, 6, 12 Rel. Per (%) -19/-13/-9 M.Cap. (INR b) 44.9 M.Cap. (USD b) 0.7 Avg Val, INRm 49 Free float (%) 78.0

Financial Snapshot (INR b) Y/E Mar 2015 2016E 2017E Net Sales 30.8 35.1 40.8 EBITDA 4.4 5.1 6.3 PAT 3.7 4.2 4.8 EPS (INR) 33.1 37.8 42.7 Gr. (%) 5.9 14.1 13.0 BV/Sh (INR) 187.5 214.0 243.9 RoE (%) 17.7 17.7 17.5 RoCE (%) 15.9 17.0 18.9 P/E (x) 12.1 10.6 9.4 P/BV (x) 2.1 1.9 1.6

Shareholding pattern (%) As On Dec-15 Sep-15 Dec-14 Promoter 22.2 22.2 22.2 DII 25.5 11.1 13.4 FII 39.1 38.7 35.8 Others 13.3 28 28.6 FII Includes depository receipts

Cyient Three knots ahead

+91 22 3982 [email protected]

Please click here for Video Link

http://www.motilaloswal.com/Videos8.html

Cyient

15 February 2016 4

One reason why the Indian ER&D opportunity appears large is under-penetration at two levels: [1] only 5% of the global ER&D spend is outsourced(v/s 14% in IT Services and 34% in BPM), and [2] India’s market share in theoutsourced portion of ER&D is 25% (v/s 61% in IT Services and 38% in BPM).

Moreover, local sourcing is increasingly becoming more prominent on accountof availability of resources, cost optimization and customization needs. This hasbeen leading to increased incremental work towards Asia-Pacific (APAC), asdemand shifts towards developing economies.

New segments expand addressable aerospace opportunity by 12x CYL recently embarked upon a new strategy (S3 – Services, Systems, Solutions) to migrate from its traditional business of Engineering Services to the provision of Solutions (integrated set of services to solve a specific business problem). It has acquired three companies in line with this strategy, thus opening up three opportunities that make its addressable market 12x larger:

[1] Manufacturing (8-10 year order book visibility, with USD8b addressable market),[2] MRO (APAC emerging as source of incremental demand – USD2.3b addressableopportunity), and[3] Defense Offset (USD1b opportunity through Rangsons and the inclusion ofservices as a part of Offset).

Expect revenue growth improvement; and margins to follow suit Organic revenue growth has been flat for the last four quarters on account of

client-specific issues. However, with most issues behind, we expect revenuegrowth to bounce back going ahead, leading to 12% CAGR over FY16-18.

Margins declined by ~400bp in FY15, thanks to pricing pressure, change inbusiness mix, reinvestments in the restructuring, and acquisition of lowermargin business. However, we expect margins to expand by 130bp over FY16-18on the back of revenue growth revival, turnaround in Rangsons, higheroffshoring, improved utilization, and lower subcontracting costs.

Valuation and view Expect revival going ahead: We expect revenue growth to pick up to 12% CAGR

over FY16-18 from 0% in FY16, with most client-specific issues behind, ramp-upin several projects, and new opportunities bearing fruit. With this and severalother levers, we also expect margins to expand by 130bp over FY16-18.Consequently, we expect EPS CAGR of 14% over FY16-18.

Buy – 40% upside: Our 1-year target price of INR550 discounts forward earningsby 13x, at a discount to peers such as PSYS and MTCL (which demonstratepotential in newer services), but at a premium to peers such as MPHL, KPIT, andNITEC (given strong competitive positioning, well defined niche and strategy todrive next leg of growth). Our price target of INR550 implies 40% upside.

Key risks: Inability to integrate acquisitions leading to failure of strategy, client-specific issues weighing on overall performance (pricing / volumes).

Stock Performance (1-year)

Cyient

15 February 2016 5

Story in charts

Exhibit 1: Expect organic revenue growth to pick up

Source: MOSL, Company

Exhibit 2: S3 strategy to propel positioning


Exhibit 3: Addressable opportunity now 12x

Source: MOSL

Exhibit 4: Rapidly growing EMS market in India

Source: MOSL, IESA

Exhibit 5: Robust MRO market led by Engines and APAC

Source: MOSL, Oliver Wyman

Exhibit 6: Increasing defense budgets and high import content to boost offset liabilities

Source: MOSL, MoD

363

438 435

478

536

5.3

20.5

-0.7

9.9 12.2

FY14 FY15 FY16E FY17E FY18E

Revenue ex. Rangsons (USDm) Growth (YoY, %)

1 1

8

2 1

Earlier Now

Design and engineering Manufacturing MRO Defence

2.4 3

3.8 4.8

6.2

8

2010 2011 2012 2013 2014 2015

Electronic manufacturing services market (USD b)

67.1 83.2

100.5

2015 2020E 2025E

Total spend on MRO (USDb)

20

56 62

57 48

2010-11 2011-12 2012-13 2013-14 2014-15

Import content in annual capital budget (%)

Cyient

15 February 2016 6

Story in charts

Exhibit 7: Expect revenue CAGR of 12% over FY16-18…


Exhibit 8: …as most client-specific issues are now behind…


Exhibit 9: …and growth can be expected from Rangsons


Exhibit 10: Margin expansion possible over FY17-18E


Exhibit 11: Rangsons currently in investment mode


Exhibit 12: Other levers in offshoring and utilization


363

447 473

523

591

5.3

23.0

5.7

10.7 12.9


Revenue (USDm) Growth (YoY, %)9.8

-3.0

4.0

-16.0

3.7

-15.5

10.5

-12.7

-27.4 -28.8

Aero

spac

e

Tran

spor

tatio

n

Off-

high

way

pro

duct

s

Sem

icon

duct

or

Med

ical

&el

ectr

onic

s

Util

ities

Com

mun

icat

ions

Ener

gy &

natu

ral r

esou

rces

Com

mer

cial

and

geo

spat

ial

Oth

ers

YTD FY16 Growth (YoY, %)

67 55

24 41 43 38

46 55

Pre

acqu

sitio

n

4QFY

15*

1QFY

16*

2QFY

16*

3QFY

16*

FY16

E

FY17

E

FY18

E

Revenue (USDm)

92 35

(392)

(42)

25 104 18.2 18.6

14.7 14.2

14.5 15.5

FY13 FY14 FY15 FY16E FY17E FY18E

Change (YoY, bp) EBITDA margin (%)

67 38 46 55

11

4.3 6.0

12.0

Pre acqusition FY16E FY17E FY18E

Revenue (USD) EBITDA margin (%)

48.8

50.7

49.8

48.6

51.7

49.7

49.1

50.7

52.2

53.5

55.2

56.7

56.1

56.3

56.6

1QFY

13

2QFY

13

3QFY

13

4QFY

13

1QFY

14

2QFY

14

3QFY

14

4QFY

14

1QFY

15

2QFY

15

3QFY

15

4QFY

15

1QFY

16

2QFY

16

3QFY

16Onsite revenue (%)

Cyient

15 February 2016 7

Leadership in the high-growth Engineering Services segment Strong outlook in ER&D led by under-penetration and local sourcing

Positive outlook for Indian ER&D industry The ER&D segment has been growing at a healthy rate. One reason the opportunity of Indian ER&D appears large is under-penetration at two levels: [1] only 5% of the global ER&D spend is outsourced (v/s 14% in IT Services and 34% in BPM), and [2] India’s market share in the outsourced portion of ER&D stands at 25% (v/s 61% in IT Services and 38% in BPM). Apart from this, higher value addition by Indian vendors, and emerging technologies of IoT and analytics amongst others have been further increasing the value proposition of Indian vendors.

Exhibit 13: Sourcing very low in ER&D compared to IT Services and BPM

Source: MOSL, NASSCOM

Exhibit 14: India has scope for market share gain in the ER&D sourcing market

Source: MOSL, NASSCOM

Exhibit 15: India gaining share in the ER&D ecosystem


Exhibit 16: Market largely untapped


CYL – a leader in Aerospace and Railways CYL is a provider of Engineering Services in as many as five verticals. Of these, it is a leader in the Aerospace and Railways verticals. While in absolute dollars, it is smaller than Tier-I vendors, Engineering Services contributes over 60% of its total revenue against 3-18% for Tier-I players.

14%

34%

5%

IT services BPM ER&D

Sourcing share in global spend (%)

61%

38%

25%

IT services BPM ER&D

India's share in global sourcing (%)

3%

8%

12%

Global ER&D spend Global sourcing India's ER&D market

Growth in 2014 (YoY, %) Global ER&D spend

(USD1,440b)

Global sourcing market

(USD68b)

India's ER&D market

(USD17b)

Cyient

15 February 2016 8

Exhibit 17: More than 60% of total revenue from Engineering


Expect high growth in Aerospace Engineering Most ongoing aircraft development programs are coming to an end in 2017. This ensures continued demand in design till FY18. The commencement of an aircraft development program implies a much larger opportunity for CYL, given the parallel design and development of its parts, components, engines, etc.

In the recent past, CYL saw an uptick on account of incremental development work on the Airbus A320neo, which is currently in the testing phase. The A320neo will enter into service later in 2015, and will be powered by the PW1100G engine from Pratt & Whitney – CYL has worked on the PW1100G. Similarly, Boeing’s ongoing/upcoming projects on the 737MAX, 787-10 and 777X can lead to sustained design demand over the next two years.

Exhibit 18: Most aircraft development programs coming to an end in 2017 Program Stage of development Entry into service (EIS) Boeing 787-9 Delivery 2014 737 MAX Final assembly 2017 787-10 Firm configuration 2018 777X Firm configuration 2020 Airbus A330neo Delivery 2015 A350 XWB Delivery 2014 Bombardier CS100 Product certification phase 2015 CS300 Product definition release phase 2016 Learjet 85 Product definition release phase nm Global 7000 Detailed design phase 2016 Global 8000 Detailed design phase 2017 Challenger 350 Product certification phase 2014 Embraer Legacy 500 Test flights 2014 Legacy 450 Maiden flight in 2013 2015


699

298

694

1,087

265 148 5% 3%

10% 18%

61%

30%

TCS INFO WPRO HCLT CYL KPIT

Engineering revenue in FY15 (USDm) Engineering revenue in FY15 (% of total revenue)

Cyient

15 February 2016 9

Exhibit 19: Engine programs in sync with aircraft development Engines Applications 1 CFM International Legacy engines CFM56-5C Airbus A340 CFM56-5A Airbus A319, A320 CFM56-3 Boeing 737 CFM56-2 Boeing 707 Current engines CFM56-7B Boeing 737 CFM56-5B Airbus A318, A319, A320, A321 Future engines LEAP Boeing 737 MAX 2 IAE V2500 Airbus A319, A320, A321 3 Pratt & Whitney JT9D Boeing 747, 767, Airbus A300, A310 PW6000 Airbus 318 PW4000 Boeing 777, Airbus A330 PW2000 Beoing 757 4 General Electric CF6 Boeing 767, Airbus A300, 310 GE90 Boeing 777 GE9X Boeing 777X GEnx Boeing 787, 747-8 5 Rolls Royce RB211-535E4 Boeing 757 RB211-524G/H–T Boeing 747, 767 Trent 700 Airbus A330 Trent 800 Boeing 777 Trent 500 Airbus A340 Trent 900 Airbus A380 Trent 1000 Boeing 787-9 Trent XWB Airbus A350 XWB Trent 7000 Airbus A330neo 6 Engine Alliance GP7200 Airbus A380


Exhibit 20: Leader amongst service providers in Aerospace

Source: MOSL, Zinnov

Cyient

15 February 2016 10

Outlook for Railway Engineering Outsourcing positive CYL is the largest player in the Indian Railway Engineering Outsourcing space, with a market share of 60-70%. The outlook for the Railway industry is robust, with expected CAGR of 2.4% over 2009-2016. Growth is likely to be driven by emerging geographies like Latin America (4.2%), CIS (3.2%), Africa/West Asia (4.1%), and Asia-Pacific (2.5%), where it has been seeing strong traction.

The company is predominantly present in the areas of rolling stock and signaling, which are seeing stronger than industry-average growth. Though CYL has been seeing some weakness in the European signaling market, the geography forms a small proportion of the total Railway Engineering revenue. Strong traction in other areas including North America has been offsetting this weakness.

Exhibit 21: Major railway investments globally Geography Major projects/growth outlook UK & Europe CP5 in UK

Network Rail's business plan (2014-19) for GBP 38b of spend Annual Scandinavian rail investment around GBP 4b Major investment programs – HS2, Crossrail 2

Middle East Investing GBP 70b in rail projects through to 2020, with Saudi Arabia, Qatar and UAE representing the biggest markets (Frost & Sullivan) Doha metro Lusail LRT Abu Dhabi metro Makkah metro Jeddah metro

Asia Pacific By 2020, the urban rail market across Asia Pacific is expected to grow to GBP 60b (CAGR 5.6%) (Frost & Sullivan)

North America By 2020, the rail transit market is expected to grow towards USD 44b per year in capital expenditure, including over USD 6.5b in Engineering Services (Frost & Sullivan)

Source: MOSL, Atkins

Exhibit 22: Emerging markets to drive growth in the global rail industry

Source: MOSL, Unife

2.0

4.2

1.8 2.0

3.2

4.1

2.5

NAF

TA

Rest

of A

mer

ica

Wes

tern

Euro

pe

East

ern

Euro

pe CIS

Afric

a/M

iddl

eEa

st

Asia

/Pac

ificMarket size 2007/08/09 (EURbn) Market size 2015/16 (EURbn) CAGR 2007/08/09 - 2015/16 (%)

Cyient

15 February 2016 11

Exhibit 23: Stronger than average growth in the areas of rolling stock and signaling

Source: MOSL, Unife

Exhibit 24: Expect strong growth in the rail technology market

Source: MOSL, Vossloh

Exhibit 25: Leader amongst service providers in Transport

Source: MOSL, Zinnov

Potential scaling up of smaller verticals CYL operates in nine verticals, of which five contribute less than 10% of total revenue each. These verticals are small in terms of absolute size too. To operate in them, CYL has made available necessary resources: skilled workforce, industry specialists, sales, etc. Given the investments, existing presence, and the company's focus to augment these verticals, scaling these verticals is likely to give a significant boost to overall performance. Moreover, once these verticals start to gain critical mass, operating leverage can kick in and lead to higher margins.

0.7

2.5

3.2 2.9

Infrastructure Rolling stock Rail control Services

Market size 2007/08/09 (EURbn) Market size 2015/16 (EURbn) CAGR 2007/08/09 - 2015/16 (%)

2.6 2.8

7.0

2.0 2.7

8.1

1.9

World NAFTA Rest ofAmerica

WesternEurope

EasternEurope

Africa/MiddleEast

Asia/Pacific

CAGR - 2012 to 2017

Cyient

15 February 2016 12

Larger, stickier and more important The S3 strategy ensures larger deal sizes, lengthier engagements and higher value addition

Dramatic shift in business model CYL took a remarkable step last year by articulating and embarking upon its S3 strategy. We believe this strategy will elevate the company’s business model, as its deal sizes will get larger, duration of deals will lengthen and the role it plays in the supply chain will become more critical.

The S3 (Services, Systems, Solutions) strategy positions CYL as a ‘concept to solution’ partner, addressing customer needs across the value chain. CYL has traditionally been present in the areas of design, embedded systems, and aftermarket services. However, with a foray into manufacturing, testing, operating, analytics and aftermarket services, it has expanded its reach across the lifecycle of a product.

Services: Discrete/ Independent/ Point offerings to solve a defined technical problem Systems: Develop/ Build/ Integrate/ Implement Systems Solutions: Integrated set of services to solve a specific business problem

Exhibit 26: The S3 Strategy


Strategically acquisitive over last few quarters… CYL had been acquiring companies to add parts that weren’t necessarily in sync with existing verticals or capabilities. Over time, this led to a company that was present in Engineering Services and Data Transformation, Network and Operations (DNO),

Cyient

15 February 2016 13

which are two distinct functions, and cut across 10 verticals, of which many were sub-scale.

With the S3 strategy in place, CYL’s acquisitions are aimed towards filling gaps in service lines to aid an across-the-value-chain presence. It has acquired (1) Rangsons Electronics that helped gain manufacturing and testing capabilities, (2) Softential for service operations management, (3) Invati Insights to augment capabilities in data analytics, and (4) Pratt & Whitney’s MRO services unit to beef up the aftermarket services practice.

Exhibit 27: Strategic acquisitions to aid S3 strategy

Company acquired Date of transaction Capabilities

Rangsons Jan-15 Manufacturing and assembly of electronic systems and structures

Softential Mar-14 Service operations management Invati Insights Aug-14 Data analytics P&W's MRO Engineering Business Jul-15 Engineering services in engine maintenance, repair and

overhaul


…leading to enhanced capabilities… Take an example of a standard tail of an aircraft. The tail is made up of the rudder, the elevator, the fin (vertical stabilizer) and a horizontal stabilizer. With its earlier capabilities, CYL would design the standard tail around specifications like size, shape, thickness, weight, etc in an iterative process to reduce weight, increase stability, and provide control movements for maneuvering in an optimum manner.

With S3, an ideal contract would involve designing the tail (as above), manufacturing / taking care of the assembly of electronic systems and/or components, collecting data on various parameters when the product is in use, predicting the need for maintenance, repair and overhaul of the part based on data, and taking the necessary preventive/corrective action on the part throughout its life.

Services dominate CYL’s revenue mix at the moment, with a contribution of ~80% to total revenue. By 2020, the company expects Services to contribute 30%, Systems to contribute 50%, and Solutions to contribute 20%.

Exhibit 28: Change in business mix going ahead


…and sharper focus Over the past few years, CYL has expanded into several verticals, creating inefficiencies in its structure and operations. At the moment, its business is spread over the broad areas of Engineering and DNO, across 10 industry verticals. The S3

Cyient

15 February 2016 14

strategy focuses on select verticals of Aerospace and Defense, and Transportation and Medical – these verticals account for 50% of current revenue.

Historically, while CYL has been able to expand presence in many verticals, it hasn’t been able to scale these up. At the moment, half the verticals it is present in have annual revenues below USD30m. Given the new strategy, a sharper focus would be crucial in the successful implementation of the strategy.

Integration, a gradual process CYL has acquired companies with capabilities in manufacturing and aftermarket in the last year and a half. However, integration of these pieces to form holistic service offerings is a gradual process. It has been taking steps to aid the transition from being a service provider to being a solutions provider by integrating its acquired capabilities. Dedication of resources to ensure smooth integration of acquisitions, investments in joint offerings and cross-selling efforts are on-going.

It is crucial to note that sales cycles in Engineering Services and manufacturing of critical components are long. We expect investments to be high in the beginning, and revenue growth to accelerate over time.

Cyient

15 February 2016 15

All-time high order books in Aerospace… …lead to attractive opportunity in Electronic Manufacturing Services

Visibility of high growth in Aerospace over next 8 years Demand for Engineering Services in the Aerospace vertical has been driven by [1] ongoing product development cycles for most aircraft original equipment manufacturers, [2] higher spending on electronics and increasing outsourcing in the Aerospace Engineering R&D space, [3] incremental spend in maintenance, repair and overhaul (MRO)/aftermarket services, and [4] data analytics.

Focus of industry to shift from design to manufacturing The four major players in the global commercial airline market are Boeing, Airbus, Bombardier, and Embraer. To replace existing aircraft programs and upgrade existing models, airline manufacturers run new aircraft programs. All these players have seen large product development initiatives over the last 10 years. Typically, the product development cycle of an aircraft is eight years. Post this, the focus of the industry will shift towards manufacturing and filling orders of aircraft. CYL’s S3 strategy goes in line with this – it has acquired capabilities in manufacturing and will be able to participate in the order fulfilling that is likely going ahead.

Exhibit 29: Declining spend of OEMs on R&D


Record order booking represents 8-10 years’ production backlog The world’s biggest aircraft manufacturers have had a three-year run of record orders on the back of a global boom in Aviation and the introduction of increasingly fuel-efficient aircraft. Together, Airbus and Boeing have an order book of close to 12,000 aircraft, representing 8-10 years’ production.

4121 3918 3298 3071 3047

2321 2482 2439 2444 2667

2010 2011 2012 2013 2014

Boeing (USDm) Airbus (USDm)

Cyient

15 February 2016 16

Exhibit 30: Record order bookings over the last 3-4 years

Source: Company, MOSL

Exhibit 31: Aircraft deliveries far lower than order bookings


Moreover, the outlook for the global Aviation sector remains strong, with Boeing expecting the fleet to double by 2032. Oliver Wyman expects the global fleet to grow at an average of 3.7% annually over 2015-2025, led by narrowbody aircraft and by Asia-Pacific/China/India.

Exhibit 32: Outlook for fleet expansion remains robust

Source: MOSL, Boeing, Oliver Wyman

246 271

959 915 1,150

573

244

538

864

1,316 1,529

1,550

878

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Annual orders: Boeing

284 370

1,055

790

1,341

777

271

574

1,419

833

1,503 1,456

1139

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Annual orders: Airbus Annual orders: Airbus

281 285 290 398 441

375 481 462 477

601 648723 762

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Annual deliveries: Boeing

305 320 378

434 453 483 498 510 534588 626 629 635

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Annual deliveries: Airbus

17,739 7,330

10,409

18,817

2013 2032

Growth Replaced

Stay in service and converted Fleet in service

13,124 16,949 21,089 4,686

5,753 7,181

3,396 3,222

2,906

2,721 3,079

3,232

2015 2020E 2025E

Narrowbody Widebody Regional jet Turboprop

23,927

34,408 29,003

Cyient

15 February 2016 17

Exhibit 33: Manufacturing spend 15-20x R&D spend


Rangsons to play crucial role in manufacturing In January 2015, CYL acquired Rangsons Electronics, a leading electronics systems design and manufacturing services company. Rangsons Electronics is a well-established ESDM and systems integration vendor, with over two decades of experience in developing highly complex systems. The company is a qualified supplier to global OEMs across Defense and Aerospace, Medical, Automotive, Telecommunications, and Industrial segments.

Exhibit 34: Revenue by verticals - Rangsons


Exhibit 35: Revenue by services - Rangsons


Robust outlook for Indian EMS industry In India, the Electronic Manufacturing Services (EMS) market has been growing at a CAGR of 26.7% over 2010-15 according to IESA. The key growth drivers for India’s EMS industry are: Increase in outsourcing activity by OEMs in India and worldwide Increasing cost of labor, inflation and the overall cost of doing business in China,

which is benefitting the Indian EMS industry Abundant supply of talented workforce, specifically in design and engineering

services Growing local and global demand for electronic products

10 12

18 21 23 17 17

20 20 19

2010 2011 2012 2013 2014

Boeing Airbus

Aerospace and

defence, 51%

Industrial, 21%

Medical, 12%

Communication, 15%

Others, 1%

System integration & box build,

79%

Printed circuit

board (PCB) assembly;

sub-systems, …

Others, 1%

Cyient

15 February 2016 18

Exhibit 36: Electronic manufacturing services market (USD b)

Source: MOSL, IESA

Rangsons integration well in progress CYL has taken several steps to ensure the smooth integration of Rangsons. This

would aid its transition from being a service provider to a solutions provider.Among the steps it has taken are:1. Created a product realization group for program management. A team of

~15 people would be dedicated to the integration of Cyient and Rangsonsand realizing benefits from it.

2. Hired a CEO for Rangsons, Mr Venki Padmanabhan, who will also beresponsible for the Systems and Solutions businesses at CYL. MrPadmanabhan has a manufacturing background and has, in the past, heldleadership positions in Royal Enfield, Chrysler, and General Motors.

3. CYL is in the process of filling a few other senior leadership positions acrossfunctions, ensuring that the executives have a manufacturing background,hence making it easier to manage a manufacturing business, which is adistinct addition to the traditional business.

4. Increased emphasis on sales training for better understanding of integratedofferings and more productivity in realizing benefits of the integration. CYLis working with the existing sales team and has hired a third-partyconsultant to ensure the smooth transition of the sales function.

5. In the process of getting comfort from existing customers about the forayinto manufacturing and integrated offerings. It is currently getting itsmanufacturing facilities visited, certified and inspected by key clients.

6. Identified 8 of its customers for cross-selling Rangsons’ offerings andintegrated offerings, to start with. Talks in progress with some of these toexpand the scope of work.

2.4 3 3.8

4.8 6.2

8

2010 2011 2012 2013 2014 2015

Electronic manufacturing services market (USD b)

Cyient

15 February 2016 19

Increasing fleet of aircrafts to lead to MRO boom Engines and Asia Pacific – the right place to be

Multi-directional growth prospects in MRO The MRO industry is being driven by several factors including: [1] increasing global fleet of aircraft, [2] higher aircraft orders from APAC, [3] new operational models on the lines of ‘service by the hour’, and [4] maintenance through smart devices (monitor, analyze, detect).

CYL recently announced the acquisitions of (1) Invati Insights, a start-up data sciences company, and (2) Pratt & Whitney’s MRO Services arm in Singapore. These would let it address a market that is expected to grow to USD101b by 2025 from USD67b now.

Exhibit 37: Strong growth expected in global MRO market


Asia-Pacific to see increased spend on MRO over next 10 years Though growth outlook for the global fleet is strong, it varies widely from region to region. This is likely to reflect in large differences in MRO demand over the next decade. The Asia-Pacific will be challenged to build the necessary infrastructure capable of handling the volume of MRO the combined region will demand.

Exhibit 38: Fleet expansion expected at 6.1% CAGR in APAC over the coming decade

Source: Oliver Wyman, Company

67.1 83.2

100.5

2015 2020E 2025E

Total spend on MRO (USDb)

7420 8142

6131

8096

1720 2717 2204

3766

6452

11687

2015 2025E

North America Europe Latin America Africa / Middle East Asia Pacific

Cyient

15 February 2016 20

Exhibit 39: Differences in regional growth rates will lead to shift in MRO spend (USD b)

Source: Oliver Wyman, MOSL

Engines to capture larger share of MRO market Fleet growth over the next 10 year is played upon by two factors: [1] increase in global aviation demand, and [2] re-fleeting (replacing old fleet with newer aircraft). The combined effect is likely to dramatically change the fleet mix over the coming decade. The share of aircraft from the 1990s will reduce to 46% in 2025 from 63% in 2015. At the same time, the share of aircraft from the 2010s will rise to 29% in 2025 from nothing in 2015.

Exhibit 40: Newer planes to constitute more of the total fleet in 2025E


Fleet addition will result in an increase in the overall MRO spend to USD100.5b in 2025 from USD67.1b in 2015, implying a robust market over the coming years.

Exhibit 41: Strong growth in MRO spend, led by fleet expansion


20 21.3 17.9

24.9

3.2 6.5 7.5

12.8 18.3

34.8

2015 2025E

North America EuropeLatin America & the Caribbean Africa / Middle EastAsia Pacific / China / India

2% 26%

9%

63%

46%

9%

16%

29%

2015 2025

1970's 1980's 1990's 2000's 2010's

14.5 15.9 16.7

27.9 37.1 46.8 12.4

15.2 19.2

12.3 15

17.8

2015 2020E 2025E

Airframe Engine Component Line

67.1 83.2

100.5

Cyient

15 February 2016 21

However, since the fleet is going to be replaced by newer aircraft, newer technology is likely to reduce maintenance costs of airframes. Consequently, the share of engines and components is likely to increase in the overall MRO spend.

Exhibit 42: Engines to get a larger share of MRO by 2025E


Acquisition of P&W’s MRO Services arm to boost presence in MRO CYL has been traditionally present in the area of Repair Engineering. To augment its capability, it recently invested in acquiring the MRO Services business of Pratt & Whitney (P&W). This further cements its Aerospace strategy of positioning as a Design-Build-Maintain partner around engines, structures and avionics & systems.

Established in 2005, P&W’s MRO Services Arm – Global Services Engineering (GSE) – Asia, is based out of Singapore. As part of the deal, CYL took over 90+ repair development engineers, with expertise in Mechanical and Aerospace Engineering. The arm specializes in aerospace propulsion and industrial gas turbines. It has annual revenue of USD10m-12m and EBITDA margin of 12-14%.

In the deal, P&W has committed to volume for four years. The business is likely to see additional growth from new clients in the Aerospace industry and offshoring to India over the medium to long term. It gives access to Singapore, which is a strategic market, given that it is home to many Aerospace companies in the areas of MRO, R&D, manufacturing, and data analytics.

Data analytics to play a crucial role in MRO The use of data analytics has been on the rise, as planes and engines can collect and monitor copious amounts of data. Health monitoring and predictive maintenance are being used increasingly, reducing the overall time-on-tool requirement for individual checks and resulting in fewer repairs. The MRO Services market is also being driven by the ability to design algorithms, manage data and put analytics to use in reducing the overall maintenance costs. New technology could drive incremental spend, and result in a reshaping of the overall MRO spend going ahead.

22% 19% 17%

42% 45% 47%

19% 18% 19%

18% 18% 18%

2015 2020E 2025E

Airframe Engine Component Line

Cyient

15 February 2016 22

Exhibit 43: Health monitoring and predictive analytics to be among most prominent technologies by 2020

Source: Oliver Wyman's MRO survey

Multiple players across the value chain have already begun ramping up investments in newer technologies centric to data. Boeing recently invested USD100m in expanding its Aircraft Health Monitoring

practice. Airbus has initiated a flight hour services (FHS) support program for aircraft

maintenance services. Boeing's Gold Care offers a similar service program. General Electric too offers applications for better visibility of engines through its

myEngines suite. Rolls-Royce and Boeing's collaboration is a good example, as it provides prompt

and well-informed advice to airlines. Data from Rolls-Royce engines and Boeingaircraft is integrated to provide comprehensive information and predictivecapabilities. This helps airlines maximize aircraft utilization, while pre-emptingmaintenance operations and improving response times.

Acquisition of Invati Insights to aid foray into data analytics CYL acquired Invati Insights in August 2014. Invati is a data analytics company that provides the services of [1] big data consulting, [2] IoT and M2M, and [3] advanced analytics across the industries of Aerospace, Rail Transport, Heavy Equipment & Off-highway, Medical & Electronics, and Oil & Gas. The acquisition would enable CYL to enter Health Monitoring and Predictive Analytics, complementing its MRO practice.

66%

66%

57%

35%

26%

25%

6%

4%

Aircraft health monitoring systems

Predictive maintenance

Live maintenance through wearable and mobile technology

Composite repair capabilities

New repair technology

Additive manufacturing

Artificial intelligence

Drone-supported maintenance

Most prominent new technologies by 2020

Cyient

15 February 2016 23

Inclusion of services as eligible offsets, a big positive In addition to the play through Rangsons

The key objective of the defense offset policy is to leverage acquisitions to develop the Indian defense industry. Offset requirements mandate at least 30% procurement of defense equipment in excess of INR20b. Four simple facts that exhibit the opportunity are:

India has the third largest armed forces in the world India is one of the largest importers of conventional defense equipment and

spends about 31.5% of its total defense budget on capital acquisitions About 60% of its defense requirements are met through imports The allocation for defense in the 2015-16 Budget was ~INR2,467b

Exhibit 44: India amongst the largest defense importers Importer Share of international arms imports (%) Main suppliers (share of importer's total imports) 2010-14

2005-09 2010-14 1st 2nd 3rd India 7 15 Russia (70%) USA (12%) Israel (7%) Saudi Arabia 1 5 UK (36%) USA (35%) France (6%) China 9 5 Russia (61%) France (16%) Ukraine (13%) UAE 5 4 USA (58%) France (9%) Russia (9%) Pakistan 3 4 China (51%) USA (30%) Sweden (5%) Turkey 3 3 USA (58%) South Korea (13%) Spain (8%) USA 3 3 Germany (18%) UK (15%) Canada (13%) South Korea 6 3 USA (89%) Germany (5%) Sweden (2%) Singapore 3 3 USA (71%) Germany (10%) Sweden (6%)

Source: MOSL, SIPRI Year Book 2015

Exhibit 45: Most of India’s capital defense requirements imported Year Indigenous Import Total % of import in total 2010-11 178 44 222 20 2011-12 119 153 272 56 2012-13 118 192 311 62 2013-14 160 209 369 57 2014-15 162 147 308 48

Source: MOSL, MOD

These facts indicate a cumulative opportunity of ~USD10b over the next five years in the defense sector. While Rangsons has been operational in subsystem manufacturing and assembly, the inclusion of services in the new offset policy proves highly beneficial for CYL’s Services business.

Inclusion of Services in defense offset policy a big positive An abeyance had been issued, restricting the use of services as offset post the Augusta Westland case, where the findings of investigations indicated the use of services to channel funds inappropriately.

The report of the Committee of Experts for amendments to DPP 2013 including formulation of policy framework cited the concern: “The present abeyance order on discharge of offsets through Services has caused considerable loss of opportunity for the Indian industry. The abeyance order needs to be reviewed at the earliest.”

Cyient

15 February 2016 24

Its recommendations included: “Abeyance order on discharge of offsets, through the avenue of Services needs to be reconsidered and services like Maintenance, Repair, Overhaul, (MRO) and Up-gradation / Life Extension, which are much more akin to manufacturing activity, setting up testing infrastructure and Engineering Design limited to 30% of the overall obligations in the concerned project, be allowed as eligible offsets.”

In December 2015, Services were reinstated as eligible for offsets. All Services would be included in offsets, except training and quality assurance, which are out of purview. Earlier, only certain Services were considered eligible for offsets. In Services, however, the total discharge of offsets cannot be more than 20% of the total offset. The 20% offset is applicable to both Engineering – Design and Services, and Software Development, in which CYL has presence. In MRO, while the shop floor work is included in the 30% category, MRO Services are in the 20% category.

This would be directly beneficial to CYL’s traditional Services business in the vertical of Aerospace & Defense (~40% total revenue). Moreover, this would also be applicable to the acquisition of P&W’s MRO Services arm in Singapore. CYL, we believe, is bound to benefit out of this, given:

CYL already works with marquee names in the Aerospace & Defense space, anumber of which have Defense arms and offset liabilities

It is a market leader in the Aerospace Engineering Services space It gets a sizeable amount from Defense, which makes it experienced in dealing

with players in the industry When services were included as eligible in offsets, CYL has worked with P&W,

Boeing and Airbus in liability discharge

The bigger beneficiary, however, would be Rangsons, which would be open to tapping the addressable market irrespective of the inclusion of Services in the new offset policy. Defense already contributes ~50% of its total revenue and it works with some of the major players in Israel, which have offset liabilities.

Apart from the offset policy, ‘Make in India’ gives another avenue for growth. Government contracts to Indian players require not less than 40% of indigenous content. This was earlier 30%. This move would further boost the Indian industry and the ‘Make in India’ proposition.

Policy changes favorable to boost offset discharge The three key changes in DIPP 2015 which should help make the environment more conducive are:

[1] The new policy offers flexibility in execution of the offset contract. OEMs will beallowed to make changes in the proposal with respect to the vendors they havechosen. If they are not satisfied with the supply from the vendor/find qualitychanges/see capability issues, they can opt for a change in vendor. This appliesretrospectively, and is application to prior RFPs too.

Cyient

15 February 2016 25

[2] There is no need for OEMs to declare their proposals in advance. The new policyallows OEMs to declare their offset partner and content one year prior to executionof the contract.[3] Services have been reinstated as eligible for offset contracts.

The new policy is expected to be out in the beginning of 2016. However, the time taken for these contracts to materialize and reflect in an uptick in deal pipeline or order book would be long considering the duration for the policy to be in effect, for contracts to be signed, and for regulatory approvals. We view this as a large opportunity in the medium term, rather than it showing up substantially in financials over the next two years.

Cyient

15 February 2016 26

Expect revival in performance going ahead Led by revenue growth acceleration and margin expansion

Expect revenue growth to bounce back in FY17 FY15 was a year of robust, industry-leading revenue growth of 21%, but accompanied with a margin decline of ~400bp. We expect margins to be stable in FY16. However, organic revenue is expected to decline by ~1%. There has been consistent disappointment either on margins or revenue growth. We expect revenue growth to revive; CYL should deliver 12% revenue CAGR over FY16-18.

Exhibit 46: Expect revenue CAGR of 12% over FY16-18…


Exhibit 47: …further aided by uptick in Rangsons (*annualized)


Our confidence stems from the following: [1] Aerospace & Defense contributes 40% of CYL’s revenue. On account of the S3strategy, start of the aerospace manufacturing cycle, foray into MRO, and potentialbenefits from discharge of offset liabilities, we expect high growth from this vertical.

[2] FY16 has been a year of multiple client-specific issues that have bogged downperformance. Revenues from several marquee clients in multiple verticals wereunder pressure, leading to a ~1% organic revenue decline – a low base for the yearsahead.

Growth in several Aerospace accounts (except P&W) was muted in 1HFY16, andshould start gaining momentum from 2HFY16.

The Semiconductor vertical saw some pressure post the takeover of IBM’ssemiconductor business by Global Foundries.

In FY15, most of the revenue growth in the Utilities vertical was driven by ramp-up in a large contract won by CYL with a North American utilities company. Thehigher base has been resulting in a decline in revenue in FY16.

The Energy & Natural Resources vertical has been seeing a decline in clientspend across vendors because of lower commodity prices and resultantpressure on clients.

There has been a consistent decline in the GIS practice for the last few quartersdue a downward pricing reset with TomTom.

363

438 435

478

536

5.3

20.5

-0.7

9.9 12.2


Revenue ex. Rangsons (USDm) Growth (YoY, %) 67

55

24 41 43 38

46 55

Pre

acqu

sitio

n

4QFY

15*

1QFY

16*

2QFY

16*

3QFY

16*

FY16

E

FY17

E

FY18

E

Revenue (USDm)

Cyient

15 February 2016 27

Exhibit 48: Multiple client-specific issues affect vertical performance


[3] We expect multiple areas to stabilize/pick-up towards the end of FY16, leading torevenue growth acceleration in the coming quarters. With this, we expect revenueCAGR of 12% over FY16-18.

Growth is expected to pick-up in multiple Aerospace accounts because ofongoing development programs. Moreover, the evolution of CYL’s offeringsbecause of the integration of CYL and Rangsons and fructification of cross-sellingefforts could lead to further acceleration.

Good growth can be expected in Transportation on account of (a) robustoutlook for the global railways industry, led by emerging geographies, (b) strongdemand for services in the areas of rolling stock and signaling, where CYL haspresence, and (c) increased traction in key accounts. Moreover, CYL has set up anear-shore facility in Europe, which should add to revenue growth in FY17.

Stability is likely in (a) Semiconductors, as the impact of IBM Microelectronicsbeing acquired by Global Foundries is behind, (b) Utilities, as the basenormalizes in FY16, and (c) Energy & Natural Resources, as most vendors areseeing a bottoming out of the downward trend in spending by clients.

Exhibit 49: Most vertical-specific issues behind now (3QFY16) Composition

(%) Revenue (USDm)

QoQ growth (%)

YoY growth (%)

Aerospace 38 41 3.7 13.5 Transportation 10 11 (4.2) (5.2) Off-highway products 5 5 (8.1) 0.2 Semiconductor 4 5 (19.2) (31.6) Medical & electronics 2 2 (0.4) 17.4 Utilities 9 9 (3.7) (31.7) Communications 19 21 5.0 (0.4) Energy & natural resources 6 6 (3.7) (18.3) Commercial and geospatial 7 7 2.5 (26.4) Others 0 0 (50.2) (62.4) Total 100 108 (0.4) (6.1)


[4] Rangsons had revenue of USD67m in FY14. However, it has clocked only USD25min revenue in the eight months post acquisition, which, when annualized is ~40%lower than in FY14. This has largely been a result of unanticipated delays in deliveryof current order book.

9.8

-3.0

4.0

-16.0

3.7

-15.5

10.5

-12.7-27.4 -28.8

Aero

spac

e

Tran

spor

tatio

n

Off-

high

way

pro

duct

s

Sem

icon

duct

or

Med

ical

&el

ectr

onic

s

Util

ities

Com

mun

icat

ions

Ener

gy &

natu

ral r

esou

rces

Com

mer

cial

and

geo

spat

ial

Oth

ers

YTD FY16 Growth (YoY, %)

Cyient

15 February 2016 28

The company has been guiding for ~USD38-40m of revenue in FY16. We see revenue growth reviving once the integration goes through, and incremental business starts to get realized from cross-selling and from combined service offerings. We expect 20% revenue CAGR in Rangsons over FY16-18, on the lower base formed in FY16E (USD38m as per our expectations).

Exhibit 50: Expect revival in Rangsons


Margin maintenance despite required investments In FY15, CYL’s EBITDA margin fell by nearly 400bp to 14.7%, despite USD revenue growth of 23% YoY (20% excluding Rangsons). Efforts were shifted towards margin improvement in FY16. Though CYL has taken several steps to recoup margins, the need for investments will, at best, cap margins to flat, when compared to last year. However, we expect margins to gradually improve over FY17-18, as revenue growth accelerates.

Exhibit 51: Expect margins to expand from FY17


Exhibit 52: Onsite driven by ramp in specific projects


67

38 46

55


Revenue (USDm)

18.2 18.6

14.7 14.2 14.5 15.5


EBITDA margin (%)

49 51 50 49 52 50 49 51 52 54 55 57 56 56 57

51 49 50 51 48 50 51 49 48 47 45 43 44 44 43

1QFY

13

2QFY

13

3QFY

13

4QFY

13

1QFY

14

2QFY

14

3QFY

14

4QFY

14

1QFY

15

2QFY

15

3QFY

15

4QFY

15

1QFY

16

2QFY

16

3QFY

16

Onsite (%) Offshore (%)

Cyient

15 February 2016 29

Exhibit 53: Utilization – scope for improvement


Exhibit 54: Subcontracting expenses still high


The margin decline was led by: [1] Higher incremental growth from a DNO project with a North American utilitiescompany, which came at relatively lower pricing terms,[2] Increase in subcontracting costs (on account of the same project) to 7.6% of salesin FY15 from 2.9% in FY14,[3] Change in business mix, as onsite revenue in DNO increased to 45% in FY15 from39% in FY14,[4] Increased investments in sales and marketing, and rebranding efforts, leading toS&M cost (as a % of revenue) of 8.4% in FY15 compared to 6.1% in FY14.[5] G&A expenses (as a % of revenue) of 14.7% in FY15, up from 12.1% a year earlier.

In FY16, we expect EBITDA margin of 14.2% compared to 14.7% in FY15, since CYL has been making investments (a) in Rangsons, (b) to propel joint offerings of CYL and Rangsons, and (c) to cross-sell products across the distinct clientele that both entities have. Other investments include a team to ensure smooth integration, training of sales force, hiring of dedicated senior management and investments in showcasing products to clients. We expect these investments to weigh on margins.

Exhibit 55: Heavy investments and long sales cycles to yield gradual results in Rangsons


71 73 71 68 66 68

71 71 72 71 71 72 73 73 73

84 85 83 80

83 80 81 81

76 78 81

75 78 79 80

1QFY

13

2QFY

13

3QFY

13

4QFY

13

1QFY

14

2QFY

14

3QFY

14

4QFY

14

1QFY

15

2QFY

15

3QFY

15

4QFY

15

1QFY

16

2QFY

16

3QFY

16

Utilisation: Engineering (%) Utilisation: DNO (%)

3.2 3.1 4.7

6.1 8.1

9.1

7.0 6.7 6.8 8.5

2QFY

14

3QFY

14

4QFY

14

1QFY

15

2QFY

15

3QFY

15

4QFY

15

1QFY

16

2QFY

16

3QFY

16

Subcontracting costs (% of revenue)

67 38 46 55

11

4.3 6.0

12.0


Revenue (USD) EBITDA margin (%)

Cyient

15 February 2016 30

For FY17/18E, we see multiple margin levers in the following:

Exhibit 56: Multiple margin levers FY15 FY16E FY17E, FY18E

Revenue growth

Organic revenue growth in FY15 was primarily driven by the lower margin DNO contract with the North American utilities company

Organic revenue expected to decline by ~1%

Expected organic revenue growth of 11% over FY16-FY18E

Rangsons Lower margin Rangsons (10-12% EBITDA margin) consolidated only for one quarter

Multiple investments expected in Rangsons in order to propel growth and ensure smooth integration with Cyient

Margins expected to expand as investments bear fruit, and delivery of orders received in FY16 kick off

Utiliaation Utilization in Engineering of 71.6% and DNO of 77.5%

Expected utilization of 73.5% in Engineering and 79% in DNO

Utilization optimized by increasing efficiency, and no net additions in employee base

Improvement expected in utilization as the company has taken several steps to improve internal efficiency. One of the more significant steps is the creation of a common resource pool for deployment of people within the organization, across different verticals

Offshore Offshore revenues at 55% v/s 61% in FY14 in DNO, led by ramp in a couple of large deals

Offshore revenues expected to further decline to 51% as ramp continues on account of long tenure of deals

Expect large deals to stabilize and start moving offshore, thus aiding margins

Pyramid rationalization Management expects rationalization to aid to 60bp in margin expansion

A lever more relevant for the longer term, and is being acted upon on a continuous basis

Subcontracting costs Jumped to 7.6% of sales in FY15, from 2.9% in FY14

Expected to decline to 7.2% on account of progress in the NA Utilities contract

Won’t go back to ~3% levels because of the constant need for resources onsite; but can be optimized from current levels


Cyient

15 February 2016 31

Initiate coverage with a Buy; TP of INR550 Valuations driven by higher value proposition, rebound in growth

Leadership in Aerospace and Railway Engineering: Leadership position in Aerospace and Railway Engineering augurs well for CYL, as India’s value proportion in the ER&D market leads to increased revenues for vendors. Moreover, the ongoing development cycles in Aerospace, and investments in rolling stock/signaling in Railways put CYL in a sweet spot. Additionally, its presence in some of the other verticals gives CYL the potential to scale up, going ahead.

Increasing value proposition through S3 strategy: CYL’s S3 strategy should help transform the company from a piecemeal service provider to a multi-service solution provider. This would make its relationships more critical, increase the duration of deals, bring more visibility to contracts, increase the average size of contracts, and help it become a more crucial player in the supply chain.

Addressable market increased by multiples: Through recent acquisitions, CYL has considerably expanded its addressable market. In Aerospace, its presence has been limited to the ~USD1b Engineering Services space. However, exposure increases to ~USD8b in Electronic Manufacturing Services, ~USD2b in MRO, and ~USD1b in Defense. Strides taken in any of these areas will auger well for overall performance.

Expect rebound in revenue growth: While organic revenue growth in FY16 is expected to decline by 1~, most client-specific issues that caused the moderation are now behind and growth should rebound next quarter onwards. With this, we expect organic revenue CAGR of 11% over FY16-18.

Margin comfort for FY17-18E: Margins have been subdued over the last few quarters on account of ongoing investments in restructuring, integration efforts, and lack of revenue growth. However, with revenue growth expected to revive, margins should expand. There is additional comfort on margin expansion, given the levers in utilization, offshoring and subcontracting costs.

Exhibit 57: Revenue growth expected to revive…


Exhibit 58: …coupled with margin expansion


363

447 473

523

591

5.3

23.0

5.7 10.7

12.9


Revenue (USDm) Growth (YoY, %)

18.2 18.6

14.7 14.2 14.5 15.5


EBITDA margin (%)

Cyient

15 February 2016 32

Value CYL at INR550 per share CYL warrants a premium: We believe CYL warrants a premium to its peers

considering : [a] its positioning in the Engineering Services market, with theabsence of legacy baggage, [b] its market leadership in multiple verticals, and [c]its premium positioning with customers (moving higher up the value chain).

Premium to historical P/E is justified, given: [a] Pick-up in revenue and earningsCAGR over FY16-18E, [b] Focused strategy, leading to increased probability ofsuperior performance, and [c] Positioning of company – transiting higher in thevalue chain as compared to the past.

We value CYL at 13x forward EPS to arrive at a fair value of INR550 per share(40% upside), at a discount to peers such as PSYS and MTCL (which demonstratepotential in newer services), but at a premium to peers such as MPHL, KPIT andNITEC, given strong competitive positioning, well defined niche and strategy inplace to drive the next leg of growth.

Exhibit 59: Valuations attractive, given revenue CAGR

Source: MOSL, Company, Bloomberg

Exhibit 60: Valuations attractive, given earnings CAGR

Source: MOSL, Company, Bloomberg

Exhibit 61: Currently at lower valuations for strong performance

Recommendation

TP INR

Revenue CAGR,

FY16-18E

EBITDA margin

expansion, FY16-18E,

bp

Earnings CAGR,

FY16-18E

PE (FY17E)

PE (FY18E)

EV/EBITDA (FY17E)

EV/EBITDA (FY18E)

ROE (FY17E)

ROE (FY18E)

Dividend yield

(FY17E)

Dividend yield

(FY18E)

TCS IN Neutral 2,575 12% (76) 14% 16.5 14.3 13.3 11.2 35.6 33.3 1.9 1.9 INFO IN Buy 1,350 13% 0 14% 16.3 14.5 11.0 9.3 25.2 24.8 2.7 2.7 WPRO IN Neutral 630 10% (109) 13% 12.8 11.3 10.1 8.7 20.8 20.6 2.3 2.3 HCLT IN Buy 1,000 32% 39 33% 13.4 11.8 9.3 7.8 28.1 26.5 2.1 2.3 TECHM IN Neutral 550 11% 65 14% 12.8 11.0 8.1 6.7 20.9 18.6 1.8 1.8 MPHL IN Neutral 520 7% 130 11% 11.2 10.2 6.8 5.7 13.6 14.2 4.7 5.1 HEXW IN Neutral 250 15% 34 16% 16.2 13.9 10.3 8.6 30.5 33.4 4.2 4.9 PSYS IN Neutral 700 16% 19 17% 14.1 11.8 7.4 6.1 20.2 22.0 2.0 2.0 KPIT IN Neutral 165 7% 77 12% 8.7 7.5 5.4 4.2 17.1 16.7 1.2 1.2 MTCL IN Neutral 1,600 18% 126 23% 16.6 13.4 10.8 8.5 28.3 28.6 1.6 1.6 NITEC IN Neutral 610 9% (39) 12% 9.8 8.8 5.2 4.5 18.5 18.0 2.1 2.1 CYL IN Buy 550 12% 130 14% 10.4 9.2 7.4 5.6 16.8 18.7 2.8 3.2


MPHL

HEXW

PSYS

KPIT

MTCL

NITEC

CYL

6.0

8.5

11.0

13.5

16.0

0% 5% 10% 15% 20%

MPHL

HEXW

PSYS

KPIT

MTCL

NITEC

CYL

6.0

8.5

11.0

13.5

16.0

0% 5% 10% 15% 20% 25%

Cyient

15 February 2016 33

Global peer comparison We compared CYL to various players based on the business that it is in. Given that it is gets placed between Engineering Services Providers and Solution Providers:

Exhibit 62: CYL undervalued compared to global peers


CYL trades at a deep discount to Indian Engineering Services Providers like TataElxsi. KPIT has been trading at a discount on account of its recentunderperformance, and relatively large proportion of legacy business that isunder pressure.

Luxoft and EPAM are foreign-based service providers that derive a significantproportion of revenue from Engineering Services / Product Development.However, their premium can also be attributed to the growth that they deliver,which is higher than most Indian providers.

Plexus and Scanfil are directly comparable to Rangsons, as they are involved inhigh-mix, low-volume EMS. However, these companies have different metricsand operate at EBITDA margins of 10-12%. We cannot value Rangsons as aseparate entity, as future deals will have integrated the capabilities of CYL andRangsons. Looking at them separately and valuing them distinctly would defeatthe purpose of the acquisition.

Bertrandt and Ricardo are end-to-end solution providers, and have metrics thatCYL is heading towards (minus the manufacturing of components).

Rangsons – a call option at current levels! If we were to consider a scenario where the integration of Rangsons fails, and we have to entirely strip the value off the acquisition hereon, our EPS estimate for FY18 would reduce by 8%. In this case, even if we consider de-rating in the stock and value it at 10x two-year rolling earnings, because of the cutting out of S3 as an opportunity (and MRO and Defense remaining intact), it would imply a target price of INR400 per share, which is its current market price. Even in the worst case scenario, the downside is limited.

32.1

8.8

20.8 17.5 11.1 8.4

12.9 15.7

10.6

Tata

Elx

si

KPIT

Luxo

ft

EPAM

Plex

us

Scan

fil

Bert

rand

t

Rica

rdo

India-based serviceproviders

MNC service providers Global high-mix, low-volume players

Solution providers

FY17 PE (x) Cyient FY17 PE (x)

Cyient

15 February 2016 34

Company description

Cyient (Bloomberg: CYL) is a provider of Engineering Services, and Data, Network and Operation Services in the fields of Aerospace, Consumer, Energy, Medical, Oil & Gas, Mining, Heavy Equipment, Hi-tech, Rail Transportation, Telecom, and Utilities. Its solutions include product development and life cycle support, process and network engineering, along with data transformation and analytics.

Exhibit 63: Revenue composition by services and verticals


Engineering, 63%

DNO, 36%

Others, 1%

Aerospace, 36%

Transportation, 11%

Off highway products,

5%

Semiconductor, 5%

Medical & electronics,

2%

Utilities, 9%

Communications, 18%

Energy & natural

resources, 6%

Commercial and

geospatial, 7%

Others, 1%

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Key management personnel

Mr Krishna Bodanapu, Managing Director & CEO Mr Krishna Bodanapu joined Cyient in 2001. In his current role, he provides the strategic direction for growth and is responsible for all operations.

Mr B Ashok Reddy, President, Corporate Affairs & Infrastructure Mr Reddy has fiduciary responsibility for all of Cyient’s subsidiaries. As Chairman of the subsidiaries, he maintains all government and industry body relationships.

Mr Ajay Aggarwal, Chief Financial Officer Mr Aggarwal has extensive international experience, spanning 27 years in financial management and commercial management at large multilocation, multiproduct organizations. He is skilled in setting up startups with expertise in funding, banking and strategic planning, business modeling, MIS, ERP implementation, capital budgeting, corporate finance, M&A and restructuring.

Mr Katie Cook, Sr VP & Head of Sales – North America Ms Katie Cook leads the North American sales and account management. She is responsible for revenue, profit and customer satisfaction objectives for Cyient’s North American operations.

Mr Tom Edwards, President, Cyient North America Mr Edwards serves as President of Cyient North America, where he is responsible for UTC and for Cyient’s North American operations.

Mr NJ Joseph, Sr VP, Strategy & Planning Mr Joseph currently heads the strategy and planning function that supports the development and execution of company-wide strategy across a number of focus industry verticals.

Mr Sanjay Krishnaa, Sr VP, Geography Head – Asia Pacific Mr Sanjay Krishnaa joined Cyient in 2000. In his current role as Senior Vice President & Geography Head, he leads Asia Pacific business operations.

Mr Sunuil Kumar Makkena, Sr VP, Data Transformation, Networks and Operations Mr Sunil Kumar Makkena was one of the first three associates of Cyient since its inception in 1991. He currently manages global delivery operations of the Data Transformation and Network & Operations (DNO) delivery unit, consisting of five verticals – Utilities, Communications, Transportation & Navigation, Energy & Natural Resources, and Content & Geospatial Services.

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Mr Anand Parameswaran, Sr VP, Human Resources & Business Excellence Mr Parameswaran heads human resources and business excellence and is responsible for positioning Cyient as a preferred employer. He works to ensure employee satisfaction and progressive career development opportunities.

Mr John Renard, President & Head of Sales – EMEA & India Mr John Renard joined Cyient in 2000. He serves as geography and sales head for the EMEA (Europe, Middle East, Africa) and India region.

Mr Rajendra Velagapudi, Sr VP, Engineering Operations Unit Mr Velagapudi is responsible for the Engineering Operations Unit of the organization, which provides services to leading product and process engineering companies globally across multiple industries.

Mr Brian Wyatt, SVP, Corporate Development Mr Wyatt joined Cyient in 2009. In his current role, he focuses on Cyient’s revenue growth strategy, marketing activities, brand management, key account management and strategic deals. He also plays an active role in evaluating strategic inorganic opportunities and post-deal integration.

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Key risks

Execution failure of S3 CYL has traditionally been a services company, and is operationally and structurally built as a services organization. With the addition of a manufacturing business, there is risk of failure to integrate Rangsons into existing operations. While Rangsons could operate as a distinct entity with a suitable management team, structure and functionality, the essence of the S3 strategy lies in the integration of offerings. Failure to successfully integrate Rangsons would mean failure in executing S3.

Inability to get more customers in Aerospace engines CYL’s Aerospace expertise is around the areas of engines, avionics, structures, aero systems and interiors. Its largest client, and part shareholder is Pratt & Whitney, a leading engine supplier to aircraft manufacturers. CYL has not been able to break through any of the other engine players in the ecosystem. While it has acquired P&W’s MRO Services arm in Singapore, and has got volume commitment from P&W for four years, success of the acquisition would lie in being able to penetrate other engine manufacturers.

Pressures of reinvestment eroding margins Since CYL is foraying into a new space, making investments in the business in the form of POCs, leadership, integration, product development, etc is a mandate. Reinvestments have been ongoing and have impacted margins negatively in recent quarters. There stands a risk of additional investments and consequent erosion of margins from current levels; despite the levers it has.

Lumpiness caused by new business Manufacturing in Aerospace typically has long sales cycles, resulting out of the critical nature of the supplied products and services. This can cause lumpiness in quarterly revenue growth, which isn’t typical of an IT services company. Since the acquisition of Rangsons, CYL has seen quarterly variations in revenue growth, and this has the potential to continue given the nature of the business. Risk of delay also stems out of elongated delivery procedures, certifications and regulatory processes.

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Exhibit 64: Operating metrics 2QFY14 3QFY14 4QFY14 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16

Geographic Mix - % Americas 56.1 56.5 58.0 60.9 63.9 65.0 63.7 64.0 64.1 63.6. Europe 28.3 29.2 28.9 29.3 27.4 26.8 25.8 24.0 24.1 23.2 Asia Pacific 15.6 14.3 13.1 9.8 8.7 8.2 10.5 12.0 11.8 13.2 Business Units - % Engineering 63.0 63.1 64.1 62.2 60.8 57.5 61.8 62.8 62.8 62.5 DNO 35.6 35.7 34.8 36.9 38.3 41.6 37.4 36.4 36.4 37.0 Others 1.4 1.2 1.1 0.9 0.9 0.9 0.8 0.8 0.8 0.5 Vertical Mix - % Aerospace 34.4 33.2 32.8 33.9 33.3 31.2 34.5 35.8 36.2 37.7 Transportation 11.4 12.5 11.8 11.2 10.4 10.1 10.4 10.4 10.6 10.2 Off highway products 5.9 5.4 5.2 4.8 5.1 4.5 5.0 5.2 5.2 4.8 Semiconductor 5.2 6.1 5.9 5.8 6.1 5.9 5.6 5.6 5.3 4.3 Medical & electronics 1.5 1.5 1.7 1.7 1.3 1.2 1.5 1.4 1.5 1.5 Utilities 10.2 11.0 10.6 10.1 10.9 12.1 11.0 10.6 9.1 8.8 Communications 13.6 12.7 14.6 14.2 15.4 18.3 16.4 16.2 18.4 19.4 Energy & natural resources 7.4 7.0 6.8 7.2 7.1 6.9 7.0 6.6 6.2 6.0 Commercial and geospatial 8.9 9.3 9.6 10.2 9.4 8.8 7.8 7.3 6.7 6.9 Others 1.5 1.3 1.0 0.9 1.0 1.0 0.8 0.9 0.8 0.4 Revenue Mix - % Onsite 49.7 49.1 50.7 52.2 53.5 55.2 56.7 56.1 56.3 56.6 Offshore 50.3 50.9 49.3 47.8 46.5 44.8 43.3 43.9 43.7 43.4 Utilization - % Engineering 68.0 71.0 71.0 72.3 70.7 70.9 72.4 72.5 73.3 72.9 DNO 80.0 81.0 81.0 76.3 78.0 80.6 75.2 78.2 78.9 80.4 Overall 74.5 76.4 76.3 74.4 74.7 76.0 73.8 75.4 76.1 76.7 Client Buckets USD1m+ 56 54 54 55 54 56 55 59 60 60 USD5m+ 17 17 19 19 20 20 20 22 21 19 USD10m+ 7 6 8 8 9 9 8 8 9 10 USD20m+ 4 3 4 3 3 4 4 4 4 2 Client Contribution - % Top 5 35.3 35.8 35.9 36.2 34.4 40.3 34.9 35.7 35.3 34.7 Top 10 48.2 49.8 50.7 51.3 48.7 50.1 49.5 51.2 50.1 49.4 Product Realisation Business Geographic Mix - % Americas - - - - - - 29.2 44.6 23.5 22.3 EMEA & India - - - - - - 15.5 37.0 28.7 51.0 Asia Pacific - - - - - - 55.3 18.4 47.8 26.7 Vertical Mix - % Aerospace and Defence - - - - - - 58.2 19.0 49.5 51.3 Industrial - - - - - - 24.7 39.0 22.4 20.7 Medical - - - - - - 13.1 20.3 11.0 11.6 Communication - - - - - - 2.6 15.3 16.1 15.0 Others - - - - - - 1.4 6.4 1.1 1.4


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Financials and valuations

Income Statement (INR Million) Y/E March FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E Sales 11,880 15,530 18,731 22,064 27,359 30,810 35,055 40,758 Change (%) 24.6 30.7 20.6 17.8 24.0 12.6 13.8 16.3 Cost of Services 7,413 9,691 11,261 13,302 17,129 19,822 22,527 26,290 SG&A Expenses 2,671 3,149 4,054 4,662 6,217 6,599 7,445 8,134 EBITDA 1,796 2,689 3,416 4,101 4,014 4,389 5,083 6,335 % of Net Sales 15.1 17.3 18.2 18.6 14.7 14.2 14.5 15.5 Depreciation 486 494 635 720 713 780 800 925 Interest 10 7 12 29 80 176 141 137 Other Income 272 175 398 187 1,236 1,332 1,551 1,164 PBT 1,572 2,363 3,166 3,538 4,457 4,766 5,692 6,437 Tax 270 835 967 1,030 1,096 1,165 1,480 1,674 Rate (%) 17.2 35.3 30.5 29.1 24.6 24.4 26.0 26.0 Eq. in earnings of affiliates 70 100 129 152 150 116 30 30 Minority Interest 1 0 0 0 0 0 0 0 PAT 1,373 1,628 2,329 2,660 3,511 3,717 4,243 4,794 Change (%) -18.3 15.5 43.3 15.1 32.0 5.9 14.1 13.0

Balance Sheet (INR Million) Y/E March FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E Share Capital 556 557 558 560 562 562 562 562 Reserves 9,737 11,018 12,667 15,325 17,879 20,481 23,451 26,807 Net Worth 10,293 11,575 13,225 15,885 18,441 21,043 24,012 27,368 Minority Interest 0 0 0 0 122 0 0 0 Loan 451 486 426 433 1,103 1,633 1,233 1,333 Capital Employed 10,744 12,060 13,651 16,318 19,666 22,676 25,245 28,701 Gross Block 5,782 6,404 7,301 7,976 9,318 10,318 11,318 12,318 Less : Depreciation -2,933 -3,345 -3,973 -4,634 -5,696 -6,476 -7,276 -8,201 Net Block 2,848 3,059 3,328 3,342 3,622 3,842 4,042 4,117 CWIP 74 198 228 71 96 70 70 70 Other LT Assets 1,735 1,251 1,350 1,605 6,365 6,465 6,565 6,665 Curr. Assets 7,196 9,529 11,194 14,448 15,703 18,499 21,410 25,417 Current Investments 334 222 610 400 336 536 736 936 Inventories 0 0 0 0 606 819 991 1,139 Debtors 2,567 3,675 4,007 4,800 5,336 6,415 7,299 8,487 Cash & Bank Balance 3,477 4,496 4,939 6,886 5,704 6,756 8,001 9,991 Loans & Advances 373 353 589 786 1,363 1,463 1,563 1,663 Other Current Assets 445 784 1,048 1,575 2,358 2,511 2,820 3,201 Current Liab. & Prov 1,109 1,976 2,449 3,147 6,120 6,200 6,840 7,567 Current Liabilities 473 1,132 1,215 1,802 3,566 3,546 3,887 4,314 Other liabilites 364 367 749 721 1,598 1,598 1,798 1,998 Provisions 273 477 484 625 956 1,056 1,156 1,256 Net Current Assets 6,086 7,553 8,745 11,300 9,583 12,299 14,569 17,850 Application of Funds 10,744 12,060 13,651 16,318 19,666 22,676 25,246 28,702 E: MOSL Estimates

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Financials and valuations

Ratios (INR Million) Y/E March FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E Basic (INR) EPS 12.5 14.5 20.7 23.7 31.3 33.1 37.8 42.7 Cash EPS 34.2 42.4 49.7 64.9 53.8 65.0 77.9 97.4 Book Value 92.4 103.9 118.3 141.5 164.3 187.5 214.0 243.9 DPS 1.2 2.5 4.5 5.0 8.0 9.9 11.3 12.8 Payout % 10.0 17.3 21.7 21.0 25.6 30.0 30.0 30.0 Valuation (x) P/E 18.2 13.8 12.1 10.6 9.4 Cash P/E #REF! 6.6 8.0 6.2 5.1 4.1 EV/EBITDA #REF! 10.0 10.9 9.0 7.4 5.6 EV/Sales #REF! 1.9 1.6 1.3 1.1 0.9 Price/Book Value #REF! 3.0 2.6 2.1 1.9 1.6 Dividend Yield (%) #REF! 1.2 1.9 2.5 2.8 3.2 Profitability Ratios (%) RoE 13.6 13.9 17.5 16.7 19.0 17.7 17.7 17.5 RoCE 12.2 18.2 20.4 20.7 16.8 15.9 17.0 18.9 Turnover Ratios Debtors (Days) 89 100 95 99 91 94 94 94 Fixed Asset Turnover (x) 1.0 1.1 1.2 1.1 1.1 1.1 1.1 1.1

Cash Flow Statement (INR Million) Y/E March FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E CF from Operations 1,707 2,008 2,397 2,941 3,282 3,830 4,436 4,933 Cash for Working Capital -689 -749 -799 -669 335 -1,231 -1,325 -1,091 Net Operating CF 1,018 1,259 1,599 2,272 3,617 2,598 3,111 3,842 Net Purchase of FA -647 -790 -922 -761 -803 -974 -1,000 -1,000 Free Cash Flow 371 469 676 1,511 2,814 1,624 2,111 2,842 Net Purchase of Invest. 878 721 -13 585 -4,479 518 548 723 Net Cash from Invest. 231 -69 -935 -176 -5,282 -456 -452 -277 Proc. from equity issues 24 17 29 52 66 0 0 0 Proceeds from LTB/STB -40 14 -27 41 399 24 -141 -137 Dividend Payments -130 -324 -422 -521 -784 -1,115 -1,273 -1,438 Cash Flow from Fin. -146 -294 -419 -427 -319 -1,091 -1,414 -1,575 Exchange difference 38 107 168 279 802 0 0 0 Net Cash Flow 1,142 1,003 412 1,947 -1,183 1,052 1,245 1,990 Opening Cash Bal. 2,336 3,492 4,528 4,939 6,886 5,704 6,756 8,001 Add: Net Cash 1,142 1,003 412 1,947 -1,183 1,052 1,245 1,990 Closing Cash Bal. 3,477 4,496 4,939 6,886 5,704 6,756 8,001 9,991 E: MOSL Estimates

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Cyient

15 February 2016 42

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Documents

Cyient - Motilal Oswal Group · in several projects, and new opportunities bearing fruit. With this and several other levers, we also expect margins to expand by 0bp over FY16-18