Zensar Tech Q4 FY18 review: Positive traction in digital services but weak margins remain a drag

The sequential improvement in Zensar Technologies Q4 FY18 earnings was mainly aided by the retail and financial verticals, though overall momentum lagged peers like Cyient and Mindtree.

Source: Company 

Consolidated sales was up 11 percent year-on-year (YoY) in constant currency terms on the back of a 15 percent YoY growth in its application management service segment. In terms of regional exposure, double-digit constant currency growth in Europe and Africa were the main contributors. Growth in retail (29 percent) and financial services (19 percent) were able to offset weakness in manufacturing (49 percent) and emerging (2 percent) verticals in the quarter gone by.

The sequential improvement (quarter-on-quarter) in dollar topline was 3.2 percent (a percent in constant currency terms), noticeably lower than other mid-tier companies like Cyient (8.3 percent) and Mindtree (5.5 percent).

EBITDA margins expanded YoY on lower other expenses and higher utilisation (84 percent versus 79 percent). However, on a sequential basis, EBITDA margins dipped 147 bps on account of higher subcontracting costs, offsetting the higher margin contribution of application management service segment. Net profit improved on lower taxes.

In Q4 FY18, digital services contributed 40.6 percent of revenue, incrementally higher than 39 percent YoY but behind that of Mindtree. For FY18, digital services constituted 38.2 percent of revenue.

The company’s recent of insurance-tech company Cynosure (for $33 million) not only adds to its digital offering but also strengthens its financial vertical (currently 19.5 percent of revenue). Cynosure operates in the property and casualty insurance space.

The company’s earlier acquisitions of Keystone and FoolProof, as well, strengthened digital capabilities and added to Zensar’s foothold in the e-commerce value chain.

The RPG Enterprise company’s margin trajectory has been significantly lower (about 300 bps) than its peers.  Going forward, changes in the business mix, higher contribution from the application management service and better offsite-onsite mix (currently: 37-63 percent) can aid margin improvement.

The company’s Infrastructure Management Service (IMS) segment (14 percent of revenue), mainly maintenance services, remains a laggard. Sales have fallen by 16 percent YoY. While restructuring is on the anvil, a substantial margin improvement can come about from this turnaround.

While company seems to be positioned for a higher share of digital revenue, subpar margins and weak growth in the manufacturing vertical remains the key drag. Similarly, expensive valuation takes the sheen of the investment case compared to midcap peers since a lot hinges on superlative performance in the years ahead. On a trailing basis, the stock is trading at 22.8 times FY18 earnings.