Cyient Limited analyst Q&A

We will now begin the question-and-answer session. We'll take our first question from the line of Ruchi Burde Mukhija from Elara Capital.

I have two questions. First, what has led to the margin expansion? Second one, could you please share what you see as outlook for your Communications vertical as we move ahead?

Our quarter-on-quarter margin improvement has two key drivers. The first is that we have had an improvement in the operating performance. Our gross margin improved quarter -on-quarter and this is happening from improvement in utilization and also from continued rate hikes which we spoke up in the previous call. The second is we continue to have benefits from in direct cost optimization, which we have done previously. So, these two are the key drivers for the quarter- on-quarter continued margin expansion. And I hand over to Karthik to address the question on communications.

Ruchi, I think we have talked about last quarter, and we said we do expect softness on the communications segment driven by the broader capex cycle that has happened over the last 2-3 years. It's taking a breather with the higher interest rates and probably this may take some time before it starts recovering. Specific to the fiber business that we do have significant exposure too. We are starting to see in few pockets and there was a slowdown that we did not anticipate earlier and some of those projects have been put on hold. We do expect that they should really jump back sometime in early Q4. At this point of time H1 to H2 would be flat in terms of communications business and w e will start seeing some of the growth by early next financial year.

Let me just also add that within this framework, our largest customer in communications continues to grow quarter and quarter and year-on-year.

We have our next question from the line of Sulabh Govila from Morgan Stanley.

So, the first question is more of a clarification from one of the remarks that you made. So , is there any sort of an impact from the geopolitical issues that we are facing in the Middle East on the sector or Cyient in anyway?

Yes, absolutely. On the Cyient DET business, we do not have much business in Israel. Of course, DLM, we do have business in Israel and about 20% of our revenue and 20% of our supply chain comes from companies in Israel . So, there is a bit of dependency. Of course , the first concern that we had was the safety of our employees, not that we have many, but we have a few in Israel in the DLM business, of course, our suppliers and customers. So that was the first concern and I'm glad to say that everybody is safe, though of course everybody has an impacted family member or an impacted colleague. Having said that, w e don't believe that there is going to be much of an impact on the D ET business in any way in Israel. Similarly, on the DLM business, like I said, 20% of business comes from there . But we're also quite confident that Israel is actually a very resilient cou ntry. Of course, there is going to be sign ificant disruption in what we do in Israel, but we focus on our employees and their families are really safe.

My second question is with respect to the guidance that we have in which we've tended to guide towards the lower end. So, for us to do the bottom end of the guide, the ask rate if I am not wrong is upwards of 3% in the next two quarters. So, just trying to understand how confident are we in terms of delivering that sort of a growth rate in the environment we are in? Whether would you expect that to gradually pick up, which would mean that 4Q would be better than 3Q, just some understanding there?

Like what I shared, our order intake has grown by 40% year -on-year, and this is led from aerospace and sustainability, and we do expect that this will continue to grow . That's the confidence on which we are trying to hold our guidance to the lower end of the range.

Would you expect the growth to gradually pick up in 3Q versus 4Q?

I hope so.

My last question is on the margins bit . We are already at 250 basis point s higher than last financial year. So just trying to understand given that we are expecting strong growth in 2H, are there any margin headwinds that we are facing due to which we're keeping the margin flat from here on?

We're still holding on to the previous margin guidance. There is still some work to do for the rest of the year . So, at this point in time we'll hold on to the previous guidance as we work through various things, we have to work through the following two quarters.

We have our next question from the line of Kawaljeet Saluja from Kotak Securities.

I have a couple of questions for Karthik. The first question is that you have seen the recent announcement of Ericsson or other comments of Ericsson wherein they expect the network spending to remain muted in calendar year '24 as well. I think we do have exposure to that market. Now, assuming that the market remains muted, do you think that the impact will filter through your communications performance or are there offsets available?

I'll answer this in two parts. One is, we have made an acquisition called Celfinet about 15 months ago and they do have the wireless side of the business and some part of the business which got impacted in Q2. We expect that part to recover in Q3 and Q4 as we see today. And because of some of the key spend that is required from the customers in UK and Europe, led by the platforms that Celfinet team has been able to build over the last three years and that has been definitely successful with many of the customers which helps in reducing their cost of operations. And two, they are also supported by the energy savings platform , which is the secondary one that we've worked on for the last two years, which is more relevant today than ever before because of the energy crisis that has been in the UK and Europe. So, those two things would lead us to see a kind of growth in Q3 and Q4 . On the fiber side of the business, significant capex that has been budgeted by the government about 18 -months ago and this has been distributed to all the states. I'm talking about it in the US. And that is likely to start getting into contract awards later in Q3 or early Q4. And we also expect that funding will drive at least significant growth over the next six to 12-months on the fiber spending. And we are betting on that . Many customers who are spending on their own, I think that is going to be curtailed in the near term and they do expect that government-sponsored or government-supported initiative will help them to spend that money over the next six to 12 months.

The second question is that any line of visibility on the refresh of the narrow bod y aircraft platform and let's say if you don't have visibility, then you know without that what's the kind of run rate and longevity of growth that you can have in it?

I think we still don't have any clear visibility of when the narrow body refresh will happen , definitely in queue, at the same time when you have duopoly situation, one is doing very well unless there is a compelling reason why both of them need to really get into a new upgrade. So that may probably happen over the next two to three years. We are still waiting for a firm decision from one of them soon. I think that will force the other one also to follow through . Meantime, what is likely to happen is that with spending in defense likely to be a key issue, and whether it is about aftermarket, MRO, all of them are likely to see some momentum and we do expect the defense spending will continue to rise over the next two to three years given the conflict situations that we are seeing across many geographies worldwide. We do expect that this will probably take the growth for a while. Having said that, the commercial side of the business has not really fully recovered , and the supply chain challenges still remain and that needs to be resolved over the next 12-24 months. So, we hope all of them will start converging into some of these new upgrade programs in the next two to three years to continue to grow beyond that.

We have our next question from the line of Mohit Jain from Anand Rathi. Please go ahead.

First is on the pricing benefits that you spoke about. So , is it complete as of Q2 or we should expect some benefit in Q3 , Q4 as well? And the related thing is, should we assume pricing benefits are largely narrow or is it broadly spread across verticals? And then I have a follow up.

There is still some more work that is left for us to do to see that we continue to receive the price benefits received so far. We will continue working on that. To your second question, not specific to aerospace only, these are broadly spread across the few segments.

Second was related to Q3 furloughs. I think you spoke about some slowdown in Q3 and then picked up in Q4 or do you expect growth to be more evenly spread given we are anticipating telecom recovery?

Mohit, I think we still don't have a clear view on how the furloughs would play out and given the demand situation on the aerospace side continues to be robust and we don't expect to be any different as compared to what we have seen in the last year and the supply chain issues for the last few years.

I'm sorry to interrupt, sir. You're not clearly audible. Can you come closer to the microphone?

So, what I was saying that is we don't have a clear view on the furloughs yet and the aerospace industry has robust demand and they continue to see as all of us are experiencing on a daily basis. I think most of the fl ights are running full and probably the capacity is still not available to meet the demand that is rising in the aerospace domain. So , that would really require some additional work that needs to be supported. So, we still hope that some of the projects wi ll still continue to be helped during the holiday season. And we still don't have a clear view. We will kind of keep you updated. Just to share additional information, we do expect Q4 to be better than Q3 and maybe it would probably skew towards Q4 more than Q3, and we don't expect any other impact on the furloughs from other sectors.

You're also anticipating some recovery in communications vertical also in Q3. Is that what you said earlier in one of the remarks?

I would say we will recover by Q4 compared to H1 we will be flat on the communications vertical.

We have our next question from the line of Sandeep Shah from Equirus Securities.

Sorry to again ask a question on the guidance. How confident are we even for the lower end of the guidance because the closest peer has downgraded growth guidance for FY24 with expectation of macro impacting the client decision -making in the last few weeks, which may impact the growth in the Q3, Q4. So, my question is, what are the assumptions in terms of rate of 3.3% compounded QoQ even grow at 15%, what are the assumptions baked in? Because in one of your statement s on communication s, you said that 2H for communication s would be flattish versus 1H. So, are you baking in almost a flattish QoQ growth in the communications?

I don't have specific number to offer on the communications for QoQ, Sandeep. But like what I said earlier, we have seen our order intake growing by 40% year-on-year. This is essentially led by the transport and the sustainability segment . Within sustainability, we see that mining and energy both are looking good . Mining customers are having difficult period because of the pricing issue, but that is also making them to drive some cost out and that would help us for the next two, three quarters. And from the energy side, some of the programs that we already won, and we are likely to win during Q3 would help us to see the growth for both Q3 and Q4. So , that's where our confidence comes from. We have not assumed any disproportionate furloughs from aerospace for Q3 because of the demand situation that we see and how our customers are asking us to provide additional help during this quarter.

Karthik, just wanted t o understand, do you believe C Y24 could be the year where new engine or aerospace design phase could be launched or it may be in CY25 rather than CY24, and will it further elevate the growth prospects of aerospace starting from next year?

I'm not sure whether there is any new program that is going to be announced unless the OEM is going to lead the way . There are multiple concepts that are being worked upon and there is no firmness in terms of specific program launch. I would also add on top of that, there will continue to be derivative programs that continue to happen as the need to reduce the emissions and increase the efficiency of. engines and some form of electric-supported engine which will reduce the capacity of the engine that is n eeded. I think sustainability is going to drive significant changes to the aircraft and the engine programs and that is where we will see the demand in the near term, as well as the MRO and aftermarket support. And with most of the aircraft running overtime, they need to be maintained and supported and this would be the second growth engine that we see in the near-term.

The last question is to Prabhakar. Just wanted to understand what are the headwinds , tailwinds which would be there especiall y on any pending wage hikes in the second half? One of the participants has already asked, I think, in the first half we are at 16.3 versus upper end of the guidance at 16.2 at the EBIT margin. So, is it fair to assume directionally still there is an upward bias in Q3, Q4 versus first half margin?

As we spoke in the previous call, the wage hikes this year are annualized and spread throughout the year. So, we can expect to see some more wage hikes to be coming in the next two quarters. There is still some more work to do on the price increases as indicated, and other operational levers we're still working on. So therefore, I'm saying a number of moving parts out there. We are very confident of the range that we have given in the previous call and at this point in time with your permission we would stay with that guidance range.

We'll take our next question from the line of Nilesh Jethani from BOI Mutual Fund.

My first question was from a two or three-year perspective considering a lot of demand for MRO etc., What can be the revenue assumptions directionally not required to quantify, but directionally what can be expected beyond '24 or you believe this MRO requireme nt is just in the interim period and you could see some declining trends?

Nilesh, I would just say that we don't have any view for fiscal '25 yet. So, as we start building up, we'll share the details with you. But we do expect that the cycle may last few more quarters before it really flattens out and because of what I shared both on commercial as well as the defense program, and one of the large fighter aircraft s which has been put into service about seven to eight years ago is coming up for service and they will get the first engine being serviced in this quarter. They said in the next five years , they need to service about 1 ,000 plus engines. So, which essentially means there could be a short to medium term demand that will continue and we do see that we are able to grow at double digits. We don't have any specific home view of whether it would be in te ens or early te ens or late te ens, we are not able to make that assessment yet.

Second question was on the transportation piece. There were earlier comments that Europe, etc., the rail department or work towards that is seeing some basically bottoming out. Wanted to understand after bottoming out, are we seeing any trends of growth or number stays there itself?

See, what is happening is for many of the governments, they have fixed budget s and they need to really prioritize where they need to spend on. With some of the challenges that are seen over the last two years, I think the homeland security or defense getting prioritized over other public infrastructure and that is a broad view that we saw . There are many programs that have been won by our customers. They're wait ing for clearances or funding to be approved for them to jumpstart the program. So, there could be some unpredictability in the near term because of what we are seeing on a broader geopolitical issue seen globally.

One last question would be on the order wins and revenue conversion. A lot of peers in the IT services commented that there has been some delay in offtake of those recent deal wins. From a Cyient perspective, the recent order wins, wanted to understand how is it translating into the revenues for us?

Yes, I think while they do take time to make decisions which may get moved to the right and there could be delays. But once they make a decision, they want to execute them faster. So, you have seen both sides of the point where they said some of the programs are shifting to the right. But once they ma ke a decision, they want to make sure that the timelines don't change for the end date. So, they really want to execute them faster, so which is definite ly what we see and there could be uncertainty around based on higher interest rates and with inflation being high and I think everybody's trying to prioritize certain investments for the near-term as compared to the long-term and those decisions are on a regular basis. We don't see any significant change in that over the last two or three months that we have seen. But you never know how things will pan out for Q3 and Q4. We don't know whether the Fed would increase the interest rates again and would it real ly create a soft landing or hard landing , there are a lot of discussions that are happening around the world. So, we don't know how things will pan out for Q3 and Q4 . Based on our current confidence we do see that once the project is awarded, they want to really get them on a faster execution side.

We have our next question from the line of Shradha from AMSEC. Please go ahead.

Hi, Karthik. On the transportation bit , in one of the large rail transportation clients, we were seeing higher offshoring which was impacting revenue for us. So, have we gotten to a stable run rate in that account or are we still seeing the impact of higher offshoring in that particular account?

Shradha, we don't want to respond on specific customer-related issues. I would just say broader commentary that I gave for rail is still valid and we do see some unpredictability because of the project start from their customers and that's one of the key issues that is facing the segment. And two, there are some specific customer issues and some of them getting merged and integrated , and some of them have gotten approval to get it integrated. So that's going to be part and parcel of the regular routine task. We don't expect any significant change in the near term as far as the rail business is concerned.

How big would auto be in new growth area and how do we see the visibility of growth rate in auto going into next year?

I think we do have an aspiration of getting this to be at least about double -digits percentage to the revenue over the next few quarters , I think that's definitely is our aspiration , and we have seen growth as we announced a few deals last quarter and we have talked about one of the perception system we are building for an industrial equipment major this quarter. We continue to see across the embedded digital services, cyber security , cloud. I think those areas continue to see interest from automotive customers. We do hope this will continue for a few more quarters.

Ladies and gentlemen, that was the last question for today. I would now like to hand the conference over to Mr. Krishna Bodanapu for closing comments. Over to you sir.

Thank you very much for your support, ladies and gentlemen, and taking the time out to be here this evening. As you know, we are facing some very uncertain times in the world with some of the geopolitical issues that are going on, but I want to assure you that we've built a very robust portfolio and also we've built a very de-risked portfolio as many of you know, while we've had some challenges in aerospace previously, there were other businesses like comms that picked up and now that there are challenges in communications, aerospace is really picking up this time. So, I just want to also highlight that we feel quite confident that we've built the de-risked portfolio, and as Karthik has said, there is some very good visibility towards the guidance that we are providing. So , thank you very much for all the support that you have provided. I also understand that it's been a busy couple of days with a lot of other calls, but may I just take a moment to invite you to our Investor Day, which will now be held on 8th December 2023 in Hyderabad. It will be an all-day session for those of you who have attended our previous investor days, you will recall that it is a great platform to understand our evolution, performance, aspiration and execution plan. On behalf of the entire Cyient team, may I extend our warm invitation to all of you to join this event. It will be our pleasure to host you at the event and hear your perspective and feedback. Our team will be in touch with you to coordinate the logistics. Thank you once again. I look forward to seeing you in December.

Ladies and gentlemen, that concludes this conference. Thank you for joining us and you may now disconnect your lines. This is a transcription and may contain transcription errors. The transcript has been edited for clarity. The Company takes no responsibility of such errors, although an effort has been made to ensure high level of accuracy