Allied Digital Services Ltd:-Future outlook and growth prospects

Scripscan:Allied Digital Services Ltd
cmp:189
Traded in:Bse-nse

Introduction:The global IT infrastructure management services (IMS) business is estimated to be $100 billion. Around 60-70% of the IMS activity can be outsourced, which translates into a huge business opportunity for Indian companies in this space. There are some players who try to benefit from the cost arbitrage model, as is done by many IT services companies. But others follow a slightly different business model. Allied Digital Services is one such established company in this space, which focuses on technology and a centralised service approach to solve most of its customers’ problems. Such a business model has dual advantages — less dependency on manpower skill, which is scarce in the market, and better manpower utilisation.With the fall in the broader market indices, its stock has lost more than one-fifth of its value from its peak. But the company’s fundamentals remain strong and it has managed to grow at a healthy rate of more than 50% in the past few quarters.I feel that the current growth momentum will continue for the next few years and investors can enter the stock at the current price levels.

BUSINESS:Allied Digital is into IT infrastructure management, security management and technical support services. The company, which has long been present in the domestic market, is now also looking at global markets. It has set up a network operation centre and security operation centre in Mumbai to serve its customers. As part of network maintenance, it tries to use different kinds of software tools to solve the problems of its customers. Currently, it solves 70-80% of the problems through technology, whereas the remaining 20-30% need human interaction. This model is 30-35% cheaper than the peoplecentric model. It also offers a package of managed security services to the clients.

FINANCIALS:Allied Digital’s net sales have risen more than three times over the past two years. Net profit has grown by four times during the same period. It has consistently tried to improve its operating margins over the past few years by using a better mix of technology and people. Its current operating margin of 24% reflects an improvement of about 500 basis points over three years. It has maintained a higher return on capital of more than 50% in the same period. Its debt-equity ratio is around 0.1. This provides enough space for the company to acquire small companies in new geographies to access new markets.

GROWTH DRIVERS :The company has started venturing into overseas territory, mainly the US and Australia. It acquired a US company called EnPointe Global Services, a carved-out subsidiary of Nasdaq-listed EnPointe Technologies in July this year. Since the deal is a mix of cash and stocks, Allied Digital will leverage the sales and marketing expertise of the parent company (EnPointe Technologies), which holds stocks of Allied Digital. This will drive its overseas earnings in future.On the domestic front, the company sees ITenabled services, pharma outsourcing, knowledge process outsourcing and contract manufacturing as some of the demand growth areas for its network and security operations.

VALUATIONS:Allied Digital Services (ADSL)'s pan-India presence, direct support model, established remote infrastructure and significant price competitiveness provide an edge against competition in the domestic IMS market.The recent En Pointe Global Services LLC (EPGS) acquisition would significantly increase international IMS revenues apart from driving domestic revenues through offshoring. Further, the SOC services are expected to register exceptional growth driven by increasing compliance requirements globally. The company expects a hefty ~US$100-million revenue contribution from EPGS in FY10.ADSL's operating margin is likely to improve by 150-200 bps in FY10 driven by lower solutions revenue share and improving profitability within IMS through offshore shift.The stock is trading at a price earnings (P/E) multiple of 6. A major part of the company’s revenue is annual in nature. Though the current economic outlook is bleak, it will be difficult for many of Allied Digital’s existing clients to cut down on non-discretionary expenses like network and security management, which are critical for the survival of any business. Further, as global majors resort to outsourcing to cut costs, it will provide more business opportunities for Allied Digital. The company’s fundamentals look sound.Investors can consider adding this stock to their portfolio.