Hexaware Technologies - Guidance, Outlook Worsen; Downgrade to Hold - Nirmal Bang

Hexaware Technologies (HTL) has downgraded its 4QCY12 dollar revenue guidance from a range of US$94.7mn-US$96.5mn to US$92mn. A substantial part of the downgrade is due to a 'sudden and unanticipated change' in project scope of a large client (among the top-10), leading to revenue from that particular project declining in 4QCY12. The client is revisiting prsoject scope and deliverables. There is also a small impact of US$450,000 from Hurricane Sandy in the US. All this is likely to lead to a 500bps-700bps decline in 4QCY12 EBITDA margin. The development has led us to cut our CY12 revenue/EBITDA/EPS estimates by 0.9%/7.1%/6.8%, respectively and CY13 revenue/EBITDA/EPS estimates by 4.7%/18.7%/17.7%, respectively. It is also likely to impact cash flow and we expect the IT firm to cut dividend payout for CY13E from 44% to 30%. We have also downgraded our PE multiple for HTL to 9.5x from 10x. Consequently, we have downgraded the stock to Hold from Buy with a revised target price of Rs105 (from Rs135 earlier). Cash/share of Rs16 likely in CY13E (17% of current market capitalisation) could provide valuation support.

'Sudden, unanticipated change' in project scope drives guidance downgrade: HTL has downgraded its 4QCY12 revenue guidance from a range of US$94.7-US$96.5mn to US$92mn. The management has attributed this downgrade to a 'sudden and unanticipated change' in the scope of a particular project of a large (among the top-10) client. At this point, the client is revisiting the scope of the project and this is likely to take some time. The revised guidance also includes a US$450,000 impact from Hurricane Sandy.

Impact on margins likely to be severe at 500-700bps in 4QCY12: While the revenue outlook has been downgraded by 2.9%-4.7%, its impact on profitability is of main concern to us. The management expects a 500bps-700bps impact on EBITDA margin in 4QCY12 because while the revenue declines, costs will remain constant and employee utilisation rate could fall, given that HTL will still have to pay the employees working on the project. On account of this, the exit EBITDA margin in 4QCY12E is likely to be 16% compared with CY12E margin of 20.6%.

Expect the impact to continue in CY13, dividend payout could also suffer: We believe the impact of this client-specific issue will continue in CY13, given the time likely to be taken by the client to decide on the revised project scope, and its impact on employee utilisation. Consequently, we have cut our CY13E volume growth estimate from 14% to 10%. It should be noted that there will be no change in the pricing of the concerned project.

Outlook and valuation: We have cut our CY12E revenue/EBITDA/EPS by 0.9%/7.1%/6.8%, respectively, and reduce CY13E revenue/EBITDA/EPS by 4.7%/18.7%/17.7%, respectively, in the wake of this development. While undoubtedly a negative, we believe the steep 31% fall in HTL's stock price over the past three months, to a large extent, captures most of the negatives at this juncture. We have also cut our dividend payout for CY13E from 44% to 30%. We have cut our target PE multiple to 9.5x (10x earlier) following lower growth expectations. Consequently, we have downgraded the stock from Buy to Hold with a revised TP of Rs105 (Rs135 earlier). Cash/share of Rs16 likely in CY13E (17% of current market capitalisation) can provide some valuation support.

Source : Equity Bulls

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