We derive comfort in the current valuation and see weakness in the currency as an added tailwind.
Zensar, the mid-sized information technology company from the RPG stable, had a decent start to FY20. Having moved up the digital learning curve bolstered by a slew of acquisitions in the past, the company saw sustenance of its revenue momentum. Margin though failed to look up.
However, management’s strong commentary on the demand environment should support earnings going forward. The company's stock has underperformed both the IT index and the Nifty year to date.
With the company at the fag end of restructuring of its business, many of the headwinds are behind. With expected earnings compounded annual growth rate (CAGR) of 17 percent in the next couple of years, the valuation at 11.4X FY21e earnings looks promising.
Source: Company
Key positives
Revenue momentum was strong. Q1 FY20 saw sequential constant currency revenue growth of 3.6 percent and 18.8 percent YoY. Since Zensar has decided to divest its non-core businesses (rest of the world and third-party hardware support), the relevant matrix to focus on is the core business (96 percent of the revenue) performance. In Q1 FY20, the core business showed sequential growth of 3 percent and YoY growth of 18 percent in reported currency.
Digital continues to be the key driver for the company growing 28 percent YoY and 7 percent sequentially and formed 48.5 percent of revenue in Q1FY20.
In terms of service offerings, Digital & Application Services grew 13.5 percent YoY largely due to a growth of 23.1 percent in Digital Services. The key driver, however, has been Cloud and infrastructure Services business driven by the exponential growth of Next Gen Cloud.
Turning to industry verticals, hi-tech and manufacturing (share of 52 percent) led by manufacturing as well as financial services (share of 24 percent) grew well.
Deal wins were healthy and the company alluded to strong demand environment. In Q1 FY20, the company won deals worth $160 mn (the deal win was $150 mn in the preceding quarter) and it announced $700 million deal win in the past one year. The company is staring at a $1 billion pipeline and of this close to 50 percent is new. The management alluded to a trend of smaller deal sizes which should augur well for its business.
The growth in top five accounts is heartening – top five and top ten clients grew by sequential 5.9 percent. The management doesn’t see any issue with its top clients and alluded to gaining market share.
Key negatives
Factoring in the impact of the accounting changes (INDAS 116) that had 140 basis points positive impact on EBIDTA margin, margin actually declined by 40 basis points sequentially. EBIT margin which is now a better matrix for like to like comparison was almost flat sequentially. The management attributed the softness to adverse exchange movement, 100 basis points drop in utilisation and investments made on hiring.
Management is targeting an EBITDA margin of 15 percent (reported margin in the quarter under review was 14.2 percent) and is banking on automation, higher offshoring and better utilisation of fresher for the same. Since the company will have a wage hike in Q2, it remains to be seen how these factors play out.
Of the industry verticals, retail was especially soft and the management feels the weakness might persist for a while but should recover as the company has a new sales team in place for this business.
Attrition while stable has not declined significantly.
Outlook
After having done close to four acquisitions in the past couple of years, Zensar is likely to go slow on inorganic expansion in the near future. The high revenue visibility, thanks to the strong deal pipeline and the margin levers that the company has at its disposal, point to decent earnings growth in the future.
With a focus on key verticals of manufacturing hi-tech, and insurance and traction in nextgen cloud services along with the divestment of non-core businesses, the quality of earnings should improve hereon. While macro headwinds remain that hasn’t impacted business so far. We derive comfort in the current valuation and see weakness in the currency as an added tailwind.Subscribe to Moneycontrol Pro and gain access to curated markets data, trading recommendations, equity analysis, investment ideas, insights from market gurus and much more. Get Moneycontrol PRO for 1 year at price of 3 months at 289. Use code FREEDOM.
