eClerx Services (downgrade to IN-LINE) - Time for a pause - Standard Chartered Securities

IN-LINE, ECLX IN, CMP INR 807.15, Price Target INR 850.0

- IER downgrades its rating on eClerx to In-Line with a revised PT of INR 850 (INR 830 earlier).

- IER expects the stock to consolidate post the recent rally as revenue growth revival is likely to get extended; an impact from specific issues at a Top-5 client remains an event risk.

- Potential margin uplift from INR weakness is a positive but is priced in current valuations, in IER's view.

- 1QFY14 results were in line; revenues at USD 33mn (2% q/q); EBITDA margin at 41.6% (+226bps); PAT was 14% above IER's estimates on higher FX gains.

- IER cuts its FY14/FY15 USD revenue estimates by 3%/7%; EPS estimates are up 9%/4% on INR reset.

1QFY14 – PAT beat on FX gains: Revenue grew 2.2% q/q to USD 33mn, in line, net of 2%/3% volume/realisation growth in the FTE revenue. EBITDA margin grew 226bps q/q to 41.6% (versus IER's 38.5% est.) as INR depreciation balanced the annual wage hike impact. PAT at INR 617mn (+28% q/q), above estimates (INR 540mn), on higher FX gains (INR 77mn).

Muted FY14 volume outlook… eClerx (ECLX) expects volume growth to stay in 1-4% q/q band over 2Q-4QFY14 as demand stays weak in Top-5 clients (76% of revenues; 3% CQGR over last 5 quarters). While pricing is stable, a portfolio mix change towards the Cable business (that is growing faster) could affect the reported realisation growth. IER sees limited upside to its 12.2% FY14 USD revenue growth estimates.

...but margin comfort remains high: INR reset pushes FY14/ FY15 EBITDA margin estimates by 281bps/117bps. Seasonal uptick in attrition in 2Q (that could lower effective per-capita manpower costs) + INR depreciation should help manage the increase in amortisation expenses (for Agilyst's payouts).

Downgrade to In-Line: ECLX has moved 23% over the past three months (versus 17% in BSE IT Index); IER believes current valuations (10x FY14F EPS vs. 5-year median of 9x) are building in potential gains from INR depreciation and a premium for its relative immunity from the proposed US immigration reforms bill. This could come under risk as the regulatory risk recedes. IER also expects EPS upgrade cycle, ex INR reset, to stay muted post management caution on mid-range demand outlook. However, ECLX's structural strengths - 40% RoE + 37% dividend payout ratio - support downside risks, in IER's view. Thus, downgrade to In-Line; IER's revised INR 850 PT (INR 830 earlier) values ECLX at 9x 12-month forward EPS.

Source : Equity Bulls

Keywords