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Hexaware Technologies (BUY)
Technology
Upgrade to BUY; good revenue momentum, low risks to margins. We believe it is
time to turn positive on select mid-caps meeting twin criteria of good volume outlook
and low risk to margins. Low risk to margins, in case of Hexaware, is admittedly a low
base benefit, but a relative positive versus other mid-caps nevertheless. We are also
more confident of Hexaware’s increased participation in the strong demand growth
environment for the industry. Raise our target price to Rs110/share (Rs72 earlier). BUY.
Upgrade to BUY; time to turn selectively constructive on IT mid-caps
After remaining Cautious on the mid-caps (despite our positive stance on the industry) for the past
several quarters, we believe it is time to turn more constructive on select mid-caps. Even as we see
an improved revenue performance in CY2011E/FY2012E from most mid-caps, potential margin
pressure continues to keep us honest on the mid-cap pack. Hexaware, with its low margin base for
CY2010E (partially impacted by one-off deal transition costs), appears a low-risk bet on margins. In
addition, inexpensive valuations (8.6X CY2011E EPS) make it an ideal candidate for re-rating.
We upgrade the stock to BUY with a revised target price of Rs110/share (Rs72 earlier).
Revenue growth confidence on Hexaware more top-down, but has bottom-up comfort as well
Our positive revenue outlook on Hexaware is by no means company-specific; we are strong
believers in the strong demand environment for the Indian IT offshore companies and expect the
mid-caps to join the party as well in CY2011E/FY2012E after missing out in the initial phase of
strong growth. That said, we also gain confidence from – (1) Hexaware’s revenue performance in
the past two quarters (13.1% and 11.2% qoq revenue growth in Jun 2010 and Sep 2010 quarters
respectively), (2) strong 4.7-6.4% qoq growth guidance for the seasonally weak Dec quarter,
(3) strong top clients performance, (4) robust new deal signings, and (5) activity pick-up in some of
Hexaware’s areas of strength viz. the travel industry, Peoplesoft implementations/upgrade, etc.
Margins – bulk of the brunt taken in CY2010; things should improve in CY2011E
Even as our overall industry margin outlook is on the cautious side, we believe Hexaware has taken
a bulk of the margin brunt in CY2010E and expect substantial margin improvement in CY2011E.
Unlike some of its other mid-sized peers, Hexaware was quick to correct course, as far as wage
realignment and attrition control is concerned. Growth, in any case, remains the biggest margin
lever for the sector; with a strong 29% US$ estimated revenue growth in CY2011E, Hexaware
should be able to drive gross margin leverage on the back of better utilization and broader
pyramid, as well as SG&A leverage to an extent. We forecast a 380 bps EBITDA margin expansion
for Hexaware in CY2011E, despite building in a stronger Rupee. Revenue growth, margin
expansion and non-recurrence of hedging losses should mitigate pressure from higher ETR.
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