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Our recent interaction with the management indicates no perceptible
change in business momentum in the current quarter. The company has
received good orders in the past few months and client spending has been
as per schedule, till date. The talks of slowdown in developed economies
have not yet impacted the company. Growth in Cisco revenues in 1Q is
expected to remain subdued with growth expected only in 3QFY12.
Integration with Akibia is in progress with cross-selling discussions
currently on. We expect margins to be impacted in 1HFY12 due to
slowdown in Cisco and salary increments (WEF July). We moderate our
FY12E EPS to Rs.30.9 (Rs.33.1). The stock is available at 5.8x FY12E earnings.
We maintain BUY with a DCF-based price target of Rs.212 (Rs.218). A delayed
recovery in major user economies and a sharper-than-expected appreciation
in rupee v/s major currencies are pronounced risks for a smaller player like
Zensar.
We spoke to the management of Zensar recently. The main
takeaways are as under:
Macro scene cautious; no major impact on business till date
n The management indicated that, the macro scene had turned cautious following
weak economic data from US and continuing weakness in European economies,
especially PIIGS economies.
n The recent economic data points have raised fears of a slowdown especially in
the post-QE2 era.
n However, at the ground level, Zensar has not experienced any impact of the
worsening macro scene.
n The management has indicated that, business flows continue along expected
lines. It has not experienced any major delays / project cancellations in the current
quarter.
n Major clients like Danahur, Assurant, UBS, CS, etc continue to scale up as per
plan.
n The company continued to win new projects in the past three months, indicating
continued client interest.
n The order flows have been good especially in the Oracle practice, with Release
12 attracting a lot of interest and resulting into additional business for Zensar.
n The company had added 12 new accounts in the previous quarter. Zensar has
participated in a few large orders in the current quarter also and expects some of
them to close in the next few weeks. If the company is able to close large orders,
it will be a big positive for the company.
n The company is looking at higher average realizations in the current fiscal.
n Client re-negotiations have yielded about 5% higher rates from select clients.
n New clients are also coming in at higher-than-average rates thereby providing
some cushion against higher salary costs.
Revenues from Cisco to pick up in 3QFY12
n For Zensar, 4QFY11 revenues were lower because of a reduction in business
from Cisco. The management had indicated that, revenues from Cisco would
pick up only WEF 3QFY12.
n The business in the current quarter is also sluggish because of the persistence of
problems faced by the routers business of Cisco, we understand.
n Revenues in 1QFY12 are expected to be similar to the previous quarter revenues,
at best.
n Cisco's fiscal ends in July and it is only in its new fiscal, that business is expected
to recover for Zensar.
n We will watch the revenue growth from Cisco closely. We have always voiced
our concern on the high dependence of the company on one client.
n The fall in Cisco revenues in 4QFY11 was surprising because we were expecting
a steady increase in revenues from Cisco over the next few quarters.
n Post Akibia's acquisition, Cisco's contribution to Zensar's revenues has fallen
from the higher levels of about 34%. This was one of the factors limiting additional
business from Cisco.
n Cisco's revenues had moderated as it likely scaled back spending in its routers
business. This business is facing significant competition from companies like IBM,
which were its SW partners (for routers business) till recently. We understand
that, Cisco's market share has reduced from the erstwhile 80% to about 60%
currently.
Akibia integration in progress - Consolidates Zensar's presence in
IMS
n Zensar has already completed the 100-day integration program with Akibia.
n The integration at the front end is complete. The training and re-training of employees
has also been completed.
n The integrated entity is now focusing on getting more orders. Negotiations with
clients on cross-selling of services is currently in progress and we expect orders to
come through by next quarter.
n Company enjoys strong relationship with its clients that include UBS, Credit
Suisse, Investec, Nomura etc. On the other hand, Akibia has some marquee customers
like Federal Reserve Bank, JP morgan chase etc.
n Company plans to cross sell some of its own and Akibia products across globe by
integrating the sales force of the two. This is also expected to increase the client
mining - for instance Nomura is Zensar's client in Asia Pacific and Akibia's client
in USA.
n Simultaneously, Zensar is looking at off-shoring several functions on Akibia, with
a view to reduce costs and bring in more alignment in functions.
n However, as of now, Akibia will remain a separate entity and the current management
will continue to run that business.
n We understand that, the acquisition will consolidate Zensar's presence in the rapidly
growing infrastructure management business. According to industry sources,
Infrastructure Management Solutions (IMS) is a $370bn market, split into Data
Centre services ($231bn), Remote Infrastructure Management ($108bn) and
Managed Services ($31bn).
n While Akibia has presence in the data centre, network and security services solutions,
Zensar has operations in the RIM business. In our opinion, these are two
complimentary services whereby, Zensar will be able to offer its offshore RIM services
to Akibia's clients.
n In turn, Akibia's on-site data centre and security services are expected to attract
and provide more comfort to several US - based clients as the same will act as
near-shore centres for those clients.
n Adding the capabilities of Akibia will further enhance Zensar's customer base for
Datacenter services while there is an equal opportunity to scale the Remote Infrastructure
Management Services business using Akibia's large datacenter customer
base.
n We understand that, both entities have a largely exclusive set of clients with
minimum overlap. Akibia has 53 active clients and serves large accounts like
Goldman Sachs, IBM and Fujitsu US.
Salary increments in 2QFY12; margin impact
n The management has indicated that, salary increments will be given WEF
2QFY12.
n The average salary hikes are expected to be in the region of 8% - 9% across
employees.
n This is likely to impact margins in that quarter.
n However, 1Q margins are also expected to be hit because of a seven-day shutdown
in Cisco account during the quarter.
n Thus, we expect margins to be under pressure atleast in 1HFY12.
Financial prospects
n We have made changes to our FY12E earnings. We have marginally reduced our
revenues for 1QFY12 and hence, for FY12. We have also moderated our margin
assumptions slightly for the company.
n We assume the rupee to average Rs.45 per USD till FY12 end.
n EPS for FY12E is expected to be Rs.30.9 (Rs.33.1).
n We have assumed tax rate to increase to 18% v/s 12% in FY11.
Valuations
n We have done our DCF analysis wherein we have also incorporated a WACC of
about 15% to compensate for the higher risks.
n Our price target is Rs.212 (Rs.218) for the stock, based on FY12E earnings.
n Sustained rise in margins and reduced attrition rates may lead us to accord
higher valuations to the stock.
Concerns
n A sharp appreciation in rupee from the current levels may impact our earnings
estimates for the company.
n A delayed recovery in major global economies could impact revenue growth of
Zensar.
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