Persistent Systems - Persisting for growth... - Centrum

Persistent Systems (Persistent), Outsource Product Development (OPD) and Product Engineering (PE) company has been consistently improving its operational performance (17.5% CAGR over FY09-12) and is likely to continue on its growth path. We expect revenue to register 15.7% CAGR over FY12-15E on the back of volume growth. Persistent is fast improving its ranking in the OPD/PE space (Source: Zinnov) in the vertical it operates and is growing faster than the industry. We believe that valuation for tier II IT companies in India will improve from the present range of 7-10x FY14E as growth prospects appear to be better on the back of higher number of deal flows. Moreover, we believe that Persistent will start getting premium rating compared to peers as 1) it is a pure play OPD player; 2) has better margin profile; and 3) has trigger in the form of inorganic opportunity and/or higher dividend payout (Cash per share Rs90). We initiate coverage on Persistent with a Buy rating.

- Revenue momentum to continue in USD terms: Persistent registered 17.5% CAGR over FY09-12, in line with its peers with a more diversified revenue stream. It has shown significant improvement on the operational front. New focus areas including mobility, cloud, collaboration, and analytics showed significant growth and now contribute 42% to the overall business. IP led revenue contribution has also increased to 14% in Q1FY13 from 3.5% in Q1FY11.

- Structural change in the industry to support growth: Emerging technologies and reduction in time to market ISVs has helped persistent grow its topline. Demand for newer technologies in the area of cloud, mobility and enterprise are growing faster where Persistent has developed strong capability. Also, recent study by various independent consultants indicates that 1) participation of mid size companies in outsourcing is likely to grow and 2) R&D offshore spending is likely to grow at 12% CAGR over CY11- 14, indicating increase in the share of offshore business.

- Key performance indicator improving with favourable revenue mix: With revenue mix changing in favour of IP based offerings, yield per person is improving YoY. Also, revenue rate from top 10 clients has been moving up consistently making stickiness is high.

Valuations - room for premium, initiate with a Buy: We expect the growth momentum to continue going forward and register 15.7% CAGR over FY12-15E. Persistent has demonstrated similar growth and higher margin compared to peers over FY09-12 and we believe that this would offer 25% premium over its peers. We value the company at 10.4x (5% above its 3 years average one year forward P/E) FY14E earnings estimate. We initiate buy with a target price of Rs436.

Key Risks: We see rupee dollar movement as the biggest risk to our assumptions since the sensitivity of currency is very high on profits compared to volume growth. Our base case assumption is 19% volume growth in FY14E and currency at Rs49/US$.

Source : Equity Bulls

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