Shares of IT company Cyient Ltd rallied as much as 10 percent in trade today (June 2) to hit a record high of Rs 1,507.70 apiece on BSE, taking their winning streak to third day amid high volumes. The stock has been rising ever since the IT firm fixed record date for final dividend. On Friday, June 2, the scrip settled more than 6 percent higher at Rs 1,461 apiece on the NSE.

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The stock has zoomed 83 percent in the last one year, against 2.5 percent rise in the S&P BSE Sensex, and just 2-3 percent in the Nifty IT index this year. Meanwhile, on a year-to-date (YTD) basis, Cyient shares climbed 79 percent.

There has also been an optimism over the Cyient's business prospects. While announcing the quarterly results in April, the IT firm also gave a positive guidance, expecting financial year (FY) 2023-24 consolidated services revenue growth to be in the range of 15-20 percent year-on-year (YoY) in constant currency (CC) terms.

According to analysts, the IT company significantly outperformed its peers in the tier-2 IT pack in the fourth quarter, delivering a constant currency revenue growth of 6.6 per cent.

Out of the 18 analysts tracking Cyient, 11 maintain a 'buy' rating and seven have a 'hold' call on the counter, according to data from Bloomberg. The average 12-month consensus price target implies a potential downside of 15.2 percent.

Engineering research and development (ER&D) companies such as Cyient and KPIT have seen a 60-80 percent rally this year. These companies are different from the IT services companies — TCS, Infosys.

What are the tailwinds driving up the stock prices of ER&D cos?

At a time when many other large-cap names such as Infosys and TCS are struggling with no return or destruction of value, ER&D stocks have been on fire. Cyient shares are up 80 percent, while the stock of KPIT is up 60 percent YTD.

The Infosys stock is down 15 percent YTD. As a reference, the Nifty IT index is just up 2.6 percent and all ER&D tech companies have massively outperformed.

Thanks to this unprecedented stock rally, some of these shares are expensive — names like Tata Elxsi, or KPIT are trading at nearly 45- 50 times, LTTS is at 28 times, Persistent is up 28 times, Cyient is at 22 times — but broadly ER&D companies are treading at premium valuations versus traditional IT services company like Infosys and TCS.

Diving deeper into what is driving this Euphoria surrounding ER&D companies, the market believes that the the business they cater to is relatively insulated from the macro headwinds and the slowdown hurting the services company.

For example, investments around autonomous, electric and connected vehicles are boosting auto, ER&D spends where KPIT Tech is present. Strong revival in the aerospace is benefiting companies like Cyient while globally, manufacturing companies are focussing on supply chain diversification and sustainability, driving ER&D budgets.

ER&D tailwinds

Auto Industry: Investments around autonomous, electric and connected vehicles.

For example, KPIT has won large deals from Renault and Honda.

KPIT Tech gets 100 percent of its revenue from auto, while Tata Elxsi gets 45 percent of its revenue from auto.

Aero industry: Record order book and lower employee headcount (due to layoffs in COVID) have induced high demand for outsourcing and offshoring.

Cyient gets 30 percent of its revenue from transportation, which includes aero and railway.

Manufacturing companies: Industrial automation, supply chain diversification, sustainability.

LTTS generates its revenue from industrial product, plant engineering.

These are the reasons why the revenue growth for the ER&D companies such as KPIT Tech, Cyient, Tata Elxsi or even Persistent has been so strong.

IT services FY23 $ revenue growth

ER&D companies guidance for FY24 represents strong growth over premium tier-1 tech companies. So, KPIT Tech is guiding for a revenue growth of 27-30 percent CC, LTTS is above 20 percent, while Cyient is 15-20 percent. This is at a sharp premium to the guidance given by IT services companies of mid-single digit growth.

What's the risk?

The risk for ER&D companies include higher contribution from discretionary projects. The IT services industry, on the other hand, has a higher portion of annuity and multi-year contracts and hence more sticky.

ER&D industry has 40-50 percent revenue coming from the project-based business, shorter cycle projects.

First Published:Jun 2, 2023 6:23 PM IST