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Strong volume led growth; one-off boosts net profit
Hexaware Technologies’ (Hexaware) Q3CY10 results clearly indicate continuing
revenue momentum. Significant growth over the past two quarters (double digit)
has been driven by project flows from large customers, in addition to take over
of employees of a customer as part of large USD 110 mn deal. Reported
revenues for the quarter grew 11% Q-o-Q and EBITDA margins improved
170bps Q-o-Q to 8.5%. This was marginally higher than our estimate. Net profit,
at INR 168 mn (excl. extraordinary items of INR 252 mn), stood higher driven
by better top line and lower–than-expected forex loss. Overall, results clearly
indicate improvement in operating metrics i.e., new client addition,
client mining, growth across all geographies and decline in attrition.
Top clients continue to drive growth
More than 50% of incremental growth over the past two quarters has been
driven by top 5 clients. However, Hexaware has been investing in account
management for its top 30 customers which should yield incremental growth
opportunities beyond its top 5 clients. The company, compared to other midcaps,
has among the best client base (from Fortune 1000 league).
Margins to head North in forthcoming quarters
With levers such utilisation (68.5%), broadening employee pyramid, offshore
shift, and SG&A leverage we anticipate EBITDA margins to improve to 15% plus
by Q4CY11E. This will imply a 470bps improvement for CY11 at 12.9% over
CY10, despite salary increases for CY11 and higher cost of lateral addition.
Profits to improve as forex drag recedes
Forex has dented Hexaware’s reported net profit over the past two years, with
average quarterly loss of INR 100 mn. This has now ended and favourable
hedges will mature going forward which will give significant delta to reported
profits. It has hedges worth USD 138 mn at average USD/INR of 48.21.
Outlook and valuations: Re-rating imminent; maintain ‘BUY’
We believe worst in terms of operating margins is behind and improvement in
margins will continue to follow. Further, as upward revenue trajectory has
continued from low revenue base in Q1CY10; 20% USD growth in CY11 can be
achieved by just 2% CQGR. At CMP of INR 86, the stock trades at a P/E of 8.2x
and EV/EBITDA of 4.5x on CY11E. We maintain our ‘BUY/ Sector
Outperformer’ recommendation/rating on the stock.
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