Lofty valuations weigh on sound fundamentals… • Persistent Systems:: ICICI Securities, PDF link

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Lofty valuations weigh on sound fundamentals…
• Persistent Systems’ Q2FY15 earnings were below our estimates led
by softness in IP-led revenues
• US$ revenues grew 5% QoQ to $76.3 million, below our 5.5%
growth and $76.6 million estimate. The services business led growth
(5.6% QoQ) but IP-led was generally soft (up 2.8% QoQ)
• Rupee revenues grew 6.7% QoQ to | 464.2 crore, in line with our
| 463.6 crore (6.6% growth) estimate
• At 20.6%, EBITDA margins declined 120 bps QoQ and were below
our 22.5% estimate, wage hikes and business re-investments, higher
doubtful debt provision and SG&A expenses
• PAT of | 71.3 crore was below our | 74 crore estimate led by lower
margins partially offset by higher other income and forex gains
Regardless of soft H1, expect FY15E to be better than FY14…
Persistent reported decent revenue growth in Q2 led by services business
(80.4% of revenues, 5.6% QoQ) and helped by IP (19.6%, 2.8%). While
services was driven by strategies around platform and digital enterprise,
Accelerite business and rCloud led IP. Persistent continues to reiterate its
FY15E growth guidance and expects it to still be better than FY14 led by
healthy pipeline, acceleration in recently acquired IPs and mining of
enterprise accounts acquired through platform business could help
sustain growth momentum. That said, achieving the same could be tricky
as it necessitates 6.5% CQGR in H2FY15E, a feat it has not achieved since
FY11.
EBITDA margins softer than anticipated as reinvestments rise…
Persistent’s Q2 EBITDA margins declined 120 bps QoQ to 20.6% vs.
21.8% in Q1 primarily led by wage hikes (-300 bps), higher doubtful debt
provision, continued investment in S&M, expansion of facilities, higher
doubtful debt provision (-120 bps) and partially offset by rising utilisation
and productivity. Commentary suggests that despite H1 softness, FY15E
PBT margins could be flat YoY (implies higher other income or lower
reinvestments which could aid EBITDA margins) led by revenue
acceleration and increasing contribution of non-linear IP revenues (20% in
Q2FY15 vs. 5% in FY09) and operational efficiencies. However, we model
FY15E EBITDA margins will decline 280 bps YoY to 23% vs. ~25% and
flat YoY estimate earlier. These margins are below Persistent’s FY09-14
average of 24.9%.
Utilisation recovers but rising attrition may be a concern…
At 70.3%, Q2 utilisation jumped 260 bps QoQ led by healthy uptick in
onsite (11.5%) and offshore (2%) volumes. The management expects the
utilisation to recover in H2 to FY14 level. LTM attrition was flat QoQ at
14.1% vs. 14% in Q1. That said, LTM attrition is up 70 bps relative to FY14
average of 13.4% likely due to just-in-time hiring in newer technologies.
Premium valuations relative to historical average dictates HOLD
We estimate Persistent will report rupee revenue, earnings CAGR of 15%,
21% over FY14-16E (average 23.5% EBITDA margins in FY15-16E), vs.
23%, 30% reported during FY09-14 (average 24.9%), driven by
acceleration in recently acquired IPs and mining of enterprise accounts
acquired through platform business. We continue to value PSL at | 1,200
i.e. at 13x its FY16E EPS of | 91. Premium valuation (35%, 14.5x) relative
to historical average (10.7x) and peers continues to dictate our HOLD
rating

link
http://content.icicidirect.com/mailimages/IDirect_Persistent_Q2FY15.pdf