If you’ve held stocks like Infosys and Wipro in your portfolio over the past year, chances are they are either sitting in the red or have made embarrassingly low returns. In fact, the entire Nifty IT index is down by 8%, which is a severe underperformance compared to the Nifty 50, which was up 16% over the same period.
But amid this turbulence is a pocket within technology services, called Engineering and R&D Services (ER&D), which is a little “hat ke”, and is rewriting the fate of the IT space, with the companies in this space displaying 75% returns on average in the past 2 years!
Joining the 4 sizeable ER&D companies (Cyient, KPIT, LTTS and Tata Elxsi) that are listed on the Indian markets is a new IPO from the Tata clan - Tata Technologies. And this one, like its peers, could very well be one of the technology services companies on steroids!
Here are 5 reasons why:
1. IT Is Different
While it is a subsection of IT, it doesn’t do very conventionally IT things, hence the outperformance. ER&D services companies provide design and engineering solutions to their clients, as opposed to IT companies that implement ERP solutions, run a bank’s BPO or develop an app for a retailer to manage all its vendors - boring.
In the current scenario of a global economic downturn, IT services companies face the brunt of delayed spending by clients, IT budget cuts, and even project cancellations. However, for ER&D services that’s hardly the case. An automobile manufacturer can’t possibly cut down on its spending on EV technology despite market conditions.
And Tata Technologies is in this exact space. It provides end-to-end engineering solutions to the automotive sector. It helps auto companies across the globe in conceptualising and developing solutions mainly in the areas of Electric Vehicles and embedded software. Most of the cool stuff you see in Tata EVs is this company’s brainchild!
2. Structural Tailwinds
It’s not just the nature of work that saves ER&D services companies from downturns, but also structural tailwinds. There is potential for the sector to continue with this sustained growth over the long term, led by:
Global ER&D spending has been increasing and is all set to cross the US$ 2.6 trillion mark by 2026, from the current US$ 1.5 trillion
Outsourcing of ER&D is fairly under-penetrated at a mere 0.6% of the total spend, compared to 25% in IT services
Within the outsourced pie, India’s relevance has been increasingly growing. It has the potential to address nearly half of the US$ 130 billion ER&D outsourcing opportunity
Being in this space, Tata Technologies could not just weather interim storms, but also benefit from a multi-year trend, resulting in sustained outperformance compared to its IT services peers.
3. Auto Is The Future
Within ER&D services, these opportunities are accentuated for the automotive sector given the systemic changes in the form of:
Energy efficiency, and replacement of combustion engines by renewable sources like electricity and hydrogen
Increasing use of electronics in vehicles across navigation, entertainment and diagnostics
Addition of electrical and electronic intervention in purely mechanical functions like powertrain systems
This is also visible in the fact that auto-centric ER&D services companies like KPIT and Tata Elxsi have managed to exhibit higher growth compared to peers.
4. Differentiated Offerings
Tata Technologies offers end-to-end solutions with a range that spans across concept design, engineering, manufacturing, testing and servicing of products. This range is much wider than the usual design plus software services provided by other ER&D players.
This makes Tata Technologies a differentiated play, with a much larger addressable market, higher dependency on clients, and even stickier revenue.
Similar to Tata Technologies, Cyient has been attempting a shift from just design to encompassing manufacturing and servicing as well. However, despite its large clientele, it has failed to materially expand its offerings over the last 5 years.
Tata Technologies could however have a successful play in this strategy given (i) backing from the Tata Group, and (ii) expertise that it can borrow from across Tata Group entities.
5. Inherent Growth Drivers
Although Tata Technologies has historically focused primarily on the automotive sector, it has recently ventured into the aerospace industry. The industry has been seeing increased technological shifts as well, especially with the use of hybrid and electric propulsion systems.
Tata Technologies already has marquee clientele in this business, with Airbus coming on board recently. Additionally, the Tata Group has plans to enter the aerospace manufacturing space in India, which would naturally benefit Tata Technologies.
Other than that, in the core automotive business, it has key customers like Tata Motors and Jaguar Land-Rover, which contribute to 40% of total revenue. While these have always been anchor clients, their share in total revenue has come down to 40% now, from 60% earlier.
New clients like VinFast have also climbed to become top customers of Tata Technologies. VinFast has been one of the most successful EV start-ups in the world. As more clients come in for services for EV and ADAS, Tata Technologies is bound to see higher growth.
Tata Technologies’ IPO is opening soon for subscription. The subscription would be open for retail investors from November 22 to November 24, 2023.
Auto-focused ER&D companies like KPIT and Elxsi are expected to see a 25% PAT CAGR over the next two years, and trade at an average TTM PE of 70x.
If Tata Technologies were to grow at and be valued at a similar rate, there seems to be a lot of upside on the stock, especially given its likely listing at 30x TTM PE.
So to sum it up - cool industry, solid growth drivers, and the Tata name backing it up - it sounds like an IPO that’s worth a read, and a space to consider (until technology eventually takes over your cars and we’re all dead)!
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