Persistent Systems - FINQUEST

Persistent Systems Ltd. (PSL) delivered a mix set of numbers in Q1FY14. Its USD revenue growth stood at 1.5% sequentially, driven by a 4.4% rise in the core product engineering business and a 12.4% decline in IP-led business. A volume growth of 3.0% sequentially and an increase in prices by 1.5% contributed to the core business growth. While IP revenues are lumpy in nature, ramp up of clients from recent acquisitions could significantly boost growth in the H2FY14. EBITDA margin declined 208bps sequentially despite the INR depreciation mainly due to higher visa costs and strategic investments made in Sales & Marketing. PSL added 16 new clients, 2 of which were large multi-million dollar accounts.

A mix of factors impacted margins in Q1FY14, but to stabilize going ahead

PSL witnessed a margin headwind from higher Visa cost (120bps), lower utilization (100bps), HPCA related costs (40bps), new sales hires (110bps) and tailwind due to currency depreciation (180bps). Moreover, the company is likely to face headwinds of offshore wage hike, fresh hiring from campuses and full impact of S,G&A investment in Q2FY14. Nevertheless, the company will have the benefit of currency depreciation, no Visa and HP Client Automation (HPCA) related costs in Q2FY14.

Though IP-led revenues declined 12.4% sequentially, but it still grew 24.7% Y-o-Y. According to the company the decline was partly due to delayed ramp-up of contracts that were part of the recent acquisition of HP Client Automation product. We believe there could be some traction from IP as these accounts start to deliver going ahead.

Management Outlook

Demand environment improving, management optimistic: The management remains confident of the improving demand environment around Social, Mobility, Analytics and Cloud (SMAC) area (~49% of revenues) and opportunities to develop new platform for various software. The recovery is likely to be led by stronger demand in the US, whereas Europe is likely to remain soft.

Investment Thesis: PSL's deal pipeline has been healthy. With enterprises and independent software vendors beginning to increase their spending budgets, product engineering budgets for these enterprises are also expected to grow over time. We believe that investments PSL made on sales and new platforms in the latest generation growth areas which include Cloud Computing, Big Data, Mobility etc would yield results going ahead. The traction from HPCA revenues would aid IP business coupled with the depreciation of the INR against the USD should ease the margin pressure going ahead.

Factoring in the above investment arguments we now expect revenue, EPS to grow 26%, 16% in FY14E and 23%, 10% in FY15E, respectively. We expect, compared to Q1FY14 EBITDA margins to improve marginally in Q2FY14E to 22.0% led by traction from HPCA and depreciation of the rupee in spite of higher wage cost. PSL is a mid-cap IT company having one of the best EBITDA margins amongst its peer set by catering to high end next-gen technologies and having a very good portion of revenues coming from non-linear sources. We believe the recovery of the U.S and enterprises loosening their purse strings are a major positive for PSL which should deliver better set of numbers going ahead. We believe PSL should command better valuations compared to other mid-cap IT companies due to its superior margins and high-end services which can't be easily replicated by competition. We reiterate our Buy rating on the stock and value the company at a slight premium compared to other midcap IT companies at 11x FY14 earnings arriving at a target price of Rs 639.

Source : Equity Bulls

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