Hexaware Moderate revenue growth; while uptick in margin‏

Background: 

Hexaware is a mid-cap IT company (CY14 revenues - USD 422mn) & a leading global provider of application development & maintenance (37.3%), enterprise services (14.6%), testing (20.8%), business intelligence & analytics (14.7%), BPO (5.7%) and Remote infrastructure management services (6.9%). The total headcount stands at 11,341 while the number of active clients stood at 234. The company’s geographical revenue break-up is as follows; America (80.8%), Europe (13.8%) and ROW (5.4%). Company’s revenue share amongst industry segment: BFSI (37.6%), Transport & Logistics (16.7%), Healthcare (16.45) and manufacturing (29.3%).

Moderate revenue growth; while uptick in margin

• In 3QCY15, Hexaware reported revenue at INR 8,184mn (+22% YoY, +6% QoQ); in dollar terms, revenue stood at USD 125.1mn (+13.7% YoY, +3.1% QoQ), led by healthy volume growth (+3% QoQ), while pricing was flat (+0.2% QoQ).
• EBITDA margins improved by 100bps QoQ to 19.2% (excludes ESOP cost) led by lower visa cost (+59 bps), forex gain (+56 bps), working days (+72 bps), one time termination cost (+82bps) and lower SG&A cost, which was partially offset by lower utilization (-132bps), off-shore wage hike (-38 bps) and gratuity (-39 bps). PAT stood at INR 1,116mn in 3QFY16 (+29.8% YoY, +12.83% QoQ).
• Among the verticals, Healthcare & insurance grew 7.8% QoQ, BFSI grew 5.6% QoQ, and manufacturing grew marginally 0.1% QoQ; while T&T de-grew 0.9% QoQ. From a geographical standpoint, North America (up 2.9% QoQ) and Europe (up 6.0% QoQ); while APAC de-grew 0.5% QoQ. Among service offerings, business process grew (+14.1% QoQ), IMS (+6.4% QoQ), enterprise solutions (+5.3% QoQ), testing (+2.9% QoQ), ADM (+1.7% QoQ); while business intelligent growth was flat in 3QCY15.
• Net addition was healthy for the quarter, taking the total headcount to 11,341. Company has added 332 employees in 3QCY15 of which 231 are fresh engineering graduates. Attrition inched up 30bps QoQ to 17.40%. Utilization fell by 170bps QoQ to 70.4%.
• DSO stood at 54 days (47 in 2QCY15); cash stood at USD 58.19mn and the company has a hedge worth USD 147.3mn @ INR 68.17/USD and € 5.7mn @ INR 75.63/€ over the next seven quarters. Company announced a second interim dividend of INR 2.25/share.
• In 3QCY15, Company added 9 new clients across its verticals, such as 5 clients in manufacturing and consumer vertical, 2 clients in BFSI segment, 1 client in Healthcare & Insurance and 1 client in travel & transportation vertical. Company indicated that it has won USD 100mn TCV worth business in 9MCY15 from new clients. The management is positive on demand given healthy demand pipeline and deal wins.

Valuation: 

Management reiterated its target to deliver inline industry average revenue growth. Company expects 55bps of EBITDA headwinds in 4QCY15 due to partial impact of wage hike. The Company’s growth outlook looks promising given its strong deal pipeline and growth in Europe geography. Uptrend in operating margins remains a key trigger to warrant further rating. At CMP of INR 244, the stock trades at 15.2x/12.8x of CY16/17E EPS. We assign a target P/E of 15x CY17E EPS and value the stock at INR 285 and thereby assign BUY rating on the stock.

Risks: 

Adverse cross currency movements, prolonged slowdown in Enterprise solutions business, deferral of deal closures and slowdown in key economies.