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Stock Insight: Gaining Altitude

Kale Consultants is poised to gain from global airline industry's move towards outsourcing non-core businesses and streamline operations to reduce costs

Kale Consultants is a strong play in business process outsourcing (BPO) and revenue accounting space. As airline companies try to cut costs and streamline revenues globally, the trend towards outsourcing non-core business will gain momentum translating into more opportunities for players like Kale Consultants.

The company is uniquely positioned to capture the emerging opportunities in the sector. After a recent restructuring, the company has moved away from the traditional revenue model of an IPR-based business, which has been the classical initial lisence fee model, where an upfront licence fee was collected from the customer and the subsequent years saw relatively small incomes from the same customer. This will help the company enter long-term contracts which will bring recurring and sustainable revenue for a longer period. While the global airline industry in general has been incurring losses for the past two years, the allied industries in the same vertical have been operating on good margins. The market for revenue accounting and proration outsourcing is likely to go up to $1.42 billion in addition to the $1.15 billion to be spent by airlines on cargo business process outsourcing, a space where Kale operates. Global air traffic is likely to grow at a CAGR of over 6 per cent over the next three years. The fastest growth is likely to take place in the Middle East, Latin America and Africa, where Kale has a good presence.

The company has recently entered into a development and commercialisation agreement with the International Air Transport Association to jointly create a revolutionary product called 'CEO Cockpit' targeted at the CEOs of the airlines.

Management
Kale Consultants was incorporated in 1986 by promoters V P Jain and N H Kale. Initially a partnership firm, the company was registered in 1980, with its office in Pune. In 1997, the company became a public limited company and was renamed as Kale Consultants Ltd. V P Jain is the CEO.

Strategy
The company has recently undergone restructuring. It has now focused attention on the airline software business with strong domain knowledge and IPR skills. Recasting the business towards an annuity-based model has paid off too. The business is likely to see a significant growth with a growing clientele and robust order book of Rs 300 crore. The company has been writing off its product development costs, which, in our view, is a prudent practice. The company has also acquired Cognosys Software, a travel technology company, to foray into the travel and transport vertical.

Growth & Profitability
The company has registered a topline growth of 5.1 per cent last year, while the airline segment registered a surge of 28 per cent. Revenue from the airline business of the company has been growing at a CAGR of 42 per cent over the past five years.

We expect revenues to keep growing at a CAGR of 38 per cent over the next two years on the back of strong order book and client addition. Recasting the business towards an annuity-based model has paid off for the company. The business is likely to see a significant growth with a growing clientele and robust order book of Rs 300 crore. Considering the emerging opportunities, the company should post a net profit of Rs 13.5 crore in 2006-07 and 23.5 crore in 2007-08.

Valuation
Compelling valuation at 5X forward earnings and significant business traction make the stock a good buy. Kale trades at an EV/EBIDTA of 3.14x FY 07E and 1.69xFY08E, which is cheap in our view. At a P/E of 8.77x its FY07E EPS of Rs 10.83 and 5.20x its FY08E EPS of 18.27, the stock is trading at a considerable discount compared to its peers. Considering the IPR value of its products and improving business fundamentals, the prevailing market price of the scrip does not capture the existing business opportunities. We expect EPS to grow at a CAGR of over 100 per cent.

Risk
Dependence on a single domain is a risk. It is true that specialised expertise in a narrow domain can be a source of strength. However it does make a company more vulnerable to a stronger competitor. One larger competitor that Kale has is WNS, a US$ 200 million company that started out as part of British Airways. Kale has bet its future on a narrow range of verticals and it will be interesting to watch its performance.

Source: Idirect