ICICI Securities: Hexaware Technologies BUY Maintained Revenue visibility remaining higher

Hexaware seems confident of maintaining high revenue visibility Q3CY10
onwards – this was evident from our recent interaction with the company. In our
view: i) recurring margin pressure is behind and incremental revenue growth will
be reflected in margin momentum from Q1CY11, ii) unfavourable legacy hedges
will get fully matured in Q3CY10, iii) less than 15% revenue growth in ’11E is
unlikely, iv) the Chennai SEZ has ample capacity, leading to lower tax rates from
FY12 versus mid-cap peers and v) net cash on books of ~Rs31/share (at end of
Q2CY10) is high – all these factors will limit any major downside. However, key
risks are any significant one-time expense provisions for employee take-over from
the recent deal win (worth US$110mn in Q2CY10) and any ensuing downgrade in
our target price – we still await clarity on the expense provision and other related
matters.
􀁦 Hexaware is confident of high revenue visibility given that: i) the company is on
track to meet Q3CY10 revenue guidance, ii) robust deal pipeline (the management’s
confidence stems from this and it expects growth visibility to continue beyond
Q3CY10 despite the fact that holidays will impact QoQ revenue growth in Q4CY10),
iii) till now, Hexaware has not witnessed any project delay or pull-back post Q2CY10
results despite a slowdown in the western economic macro environment, but the
management is cautious and iv) growth visibility is largely from the US, with hopes of
revival in Europe and rest of the world (RoW) from CY11. We believe that less than
15% dollar revenue growth in CY11 is unlikely (Chart 1).
􀁦 Margin to bounce back from CY11. Our interactions with the management indicate
that Q3CY10 margin may increase QoQ, albeit marginally; the earlier guidance had
indicated flat margins. However, margin headwinds in H2CY10 persist: i) onsite
wage inflation effective Q3CY10 (~3-4% hike) and ii) knowledge transition cost
relating to the new deal ramp-up till Q4CY10. After Q4CY10, we expect margin to
bounce back with high revenue visibility resulting in productivity gains and SG&A
leverage (as most of the S&M investment will happen by CY10). Also, Hexaware will
enjoy bargaining power as regards high billing rates in ’11 given its specialisation in
testing, risk management, Business Intelligence and Peoplesoft HR services and
niche positioning in Travel & Transport vertical.
􀁦 One-time expense provisions in Q3CY10 can be significant. During Q2CY10
results, the management had disclosed the possibility of expense provision for
employee take-over from the recent deal win (from a US Fortune-500 client worth
US$110mn in Q2CY10). This could be a risk to our target price as it may lead to
lower treasury. We are also awaiting further details on expense quantification,
margins from the new deal win etc.