Strong fundamentals with possible future consolidation in IT space -Hexaware Technologies :Centrum

Hexaware is a global provider of information technology (IT) and process outsourcing services. It focuses on three verticals: Banking, Financial Services and Insurance (BFSI); Travel, Transport, Hospitality and Logistics (TTHL), apart from other emerging verticals like life sciences and healthcare, manufacturing and professional services. The company’s technology solutions include enterprise solutions, business intelligence and analytics, quality assurance and testing services, human resource IT services, application development and management, technology consulting services and business process outsourcing services
Hexaware is now witnessing better traction in its operational performance since last 6-9 quarters with strong deal wins (close to US$600 million) and focus on top clients which gives visibility to deliver 20% revenue growth in CY2012. Hexaware reported 37.5% YoY growth in revenue to Rs.1451 crore and net profit of Rs.267 crore, a growth of 148.2% in CY2011. The growth momentum continued for Hexaware as is evident from its Q2CY2012 results, where it reported a growth of 49.7% YoY (14.1% QoQ) in revenue and 47.8% YoY (1% QoQ) in PAT.
Hexaware registered 7.2% CQGR in revenue and 22% in EBITDA over last 9 quarters. Offshore revenue share has increased from 40.8% in Q1CY2011 to 46.6% in Q2CY2012. Its attrition rate has come down significantly to 9.6% from 19.6%. The company added 51 clients in CY2011 and another 24 clients in 1HCY2012. Utilization rate at 70% including trainees offers further room to improve operating margin which has already seen improvement of ~860 bps to 22.9% over Q1CY2011 to Q2CY2012. It has a strong balance sheet with zero debt and cash & cash equivalents at Rs 429.6 crore (Rs.14.50 per share) as on June 30, 2012.
With the recent acquisition of Patni by iGate, we believe there can be further consolidation in the mid and small sized IT companies and the average PE multiple of companies like HTL. We believe that HTL could be one of the possible candidates for any further consolidation in the IT space as its promoters holding is 27.9% spread across 6 individuals.
Since the IT industry growth is tapering off and the big IT companies are posting poor growth, we believe that the major IT players will try and go in for consolidation and acquire mid-sized or small sized IT companies as a strategy for growth. In case any consolidation activity does not take place in HTL, on a purely fundamental basis, Strong client additions, visibility to achieve its revenue guidance of 20% for CY2012, one of the lowest debtor days of 66 days and high return ratio of 33% places the company ahead of mid tier IT companies and makes a strong case for re-rating at the current market price of Rs.121, It is trading at attractive valuations of 10.5x its CY2012E EPS of Rs.11.46 and at 9.3x of its CY2013E EPS of Rs.12.94. Moreover, high dividend yield of ~5% (expectation of Rs.6.0 per share in CY2012) appears attractive

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