eClerx Services - Back on track - SCB

ECLX IN, upgrade to OUTPERFORM (from In-Line), last close INR 700.00, PT INR 830.00

- We upgrade eClerx (ECLX) to Outperform; our revised PT of INR 830 (INR 690 earlier) implies 19% upside.

- Recent management interactions suggest a stable revenue trajectory over 2HFY13-FY14; margin management could get an uplift from improving bench management at Agilyst.

- We see improved financials over 2HFY13 after a weak 1H; (3.7% q/q USD revenue growth + 200bp q/q EBIT margin expansion in 3QFY13 on our estimates).

- Improved mid-range margin outlook could ease overhang; offers good entry point, in our view, to play the structural positives: a pedigreed management + strong referral base + high RoE/dividend payout ratio.

Revenue growth recovering, albeit at a slow pace. Recent management interactions indicate volume growth is stabilising after a soft 1HFY13. In financial services (c.43% est. revenue share), clients are firming up their location strategies, a positive for FY14 volume growth. Pricing pressure could ease post the milestone-linked cuts in 1HFY13. Growth momentum in media (erstwhile Agilyst) is likely to sustain on strong deal pipeline.

Expect improved margin outlook...ECLX is working towards reducing the shadow staffing at Agilyst from 35-40% currently to 20-25% by mid-CY13. We see this as a key margin lever over 2HFY13-FY14. (A 5ppt cut could drive cons. EBIT margin by 50bp on our estimates.) Also, manpower cost management should stabilise after wage rationalisation in 2Q13; ECLX sees a tighter aligning of wage-hike to pricing increase in FY14.

...that could drive 17% FY13-FY15 EPS CAGR. We broadly retain our USD revenue forecasts (17% CAGR over FY14-15); our FY13/FY14 EPS estimates are up 7%/9%, building tighter margin control (+222bp/+281bp for FY13/FY14 EBIT margin).

Time to focus back on structural positives. We reiterate our bias on ECLX's core strengths: a pedigreed management team; strong client referral base - 96% of 1H13 revenue came from Fortune/FT500 companies (c.50% of client base); and a strong balance sheet (no debt, DSO in 50-70 band, 55% FY12 RoE).

Upgrade to OP; PT raised to INR 830. The stock's near-term weakness (-11% over 4QCY12) underscores our earlier caution (eClerx Services - Quality but at a price, 10 Oct. 2012). Post the underperformance and improved margin outlook, we upgrade to OP; our revised INR 830 price target (from INR 690) is mainly from EPS upgrade + roll-forward; we retain our target multiple at 10x 12M forward EPS, 9% discount to its five-year median PER, pending top-line growth acceleration.

Source : Equity Bulls

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