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Hexaware is an emerging alternative for Fortune/Global 1000 clients, in our view, with its
specialised services and increasing wallet share. It is one of the few mid-cap IT stocks with
improving revenue (on the back of recent deal wins) and margin visibility. Improving cash
flow/dividend offer downside protection. Buy.
Emerging alternative for large clients, as reflected in many recent large deal wins
Hexaware has largely moved away from growing via small projects, thereby addressing
growth volatility. Led by 1) a change in management structure in 2008 (addition of CXO-level
employees from Wipro/HCL Tech), 2) an increased focus on vertical expertise (with
specialised services) and client mining, and 3) an ongoing check on cost efficiencies, we
believe it is shaping up to achieve consistent profitable growth. This is reflected in five large
deal wins in past 12-15 months with total contracted value (TCV) above US$15m-25m each
(including two large deals over US$100m each), which gives us confidence that it has better
revenue visibility than peers despite increased macro headwinds (we estimate incremental
revenues through ramp-up of these deals will form 33% of 2011F incremental revenues).
Margins have doubled in the past four quarters, but we expect further improvement
EBITDA margins improved 853bp to 15.3% in 2Q11 (6.8% in 2Q10). We believe further
improvement in margins is likely given levers, including: 1) SG&A (it has one of the highest
SG&A cost ratios vs peers) and utilisation rates; 2) an employee pyramid with increasing
recruitment of freshers; and 3) improving offshoring (it has one of the lowest offshore revenue
contributions). Even below the EBITDA line, it has relatively low risk from rupee appreciation and
increasing tax, with hedge cover worth US$168m at an average rate of Rs48.2 and 40-50% of
India-based employees within special economic zones (SEZs).
We initiate coverage at Buy
We initiate with a Buy rating given our estimates of USD revenue/EBITDA/EPS CAGRs of
23%/47%/55% over 2010-13. Our Rs91 target price values EPS of the four quarters ending 31
March 2013F at around 11x PE (at a 40-50% discount to our fair PE for industry benchmarks
TCS and Infosys, which have March year ends) and is at the higher end of the mid-cap peers
range, which we see as justified given we expect better margins, return ratios, growth visibility,
dividends (4.7% yield in 2011F), and improving cash flows. Key risks are a significant slowdown
in western economies, high client concentration and discretionary revenues.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Hexaware is an emerging alternative for Fortune/Global 1000 clients, in our view, with its
specialised services and increasing wallet share. It is one of the few mid-cap IT stocks with
improving revenue (on the back of recent deal wins) and margin visibility. Improving cash
flow/dividend offer downside protection. Buy.
Emerging alternative for large clients, as reflected in many recent large deal wins
Hexaware has largely moved away from growing via small projects, thereby addressing
growth volatility. Led by 1) a change in management structure in 2008 (addition of CXO-level
employees from Wipro/HCL Tech), 2) an increased focus on vertical expertise (with
specialised services) and client mining, and 3) an ongoing check on cost efficiencies, we
believe it is shaping up to achieve consistent profitable growth. This is reflected in five large
deal wins in past 12-15 months with total contracted value (TCV) above US$15m-25m each
(including two large deals over US$100m each), which gives us confidence that it has better
revenue visibility than peers despite increased macro headwinds (we estimate incremental
revenues through ramp-up of these deals will form 33% of 2011F incremental revenues).
Margins have doubled in the past four quarters, but we expect further improvement
EBITDA margins improved 853bp to 15.3% in 2Q11 (6.8% in 2Q10). We believe further
improvement in margins is likely given levers, including: 1) SG&A (it has one of the highest
SG&A cost ratios vs peers) and utilisation rates; 2) an employee pyramid with increasing
recruitment of freshers; and 3) improving offshoring (it has one of the lowest offshore revenue
contributions). Even below the EBITDA line, it has relatively low risk from rupee appreciation and
increasing tax, with hedge cover worth US$168m at an average rate of Rs48.2 and 40-50% of
India-based employees within special economic zones (SEZs).
We initiate coverage at Buy
We initiate with a Buy rating given our estimates of USD revenue/EBITDA/EPS CAGRs of
23%/47%/55% over 2010-13. Our Rs91 target price values EPS of the four quarters ending 31
March 2013F at around 11x PE (at a 40-50% discount to our fair PE for industry benchmarks
TCS and Infosys, which have March year ends) and is at the higher end of the mid-cap peers
range, which we see as justified given we expect better margins, return ratios, growth visibility,
dividends (4.7% yield in 2011F), and improving cash flows. Key risks are a significant slowdown
in western economies, high client concentration and discretionary revenues.
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