ExlService: Strong Growth Momentum With A Conservative Guidance

Investment thesis

I recommend a buy rating for ExlService Holdings (NASDAQ:EXLS). EXLS is a provider of analytics and digital solutions worldwide, working in partnership with businesses to help them achieve their goals and expand. Results for 4Q22 were significantly better than expected, and management provided guidance for CY23 that suggested 11-14% revenue growth excluding FX impact. Given the consistency in key verticals and the sustained strength of the backlog, I believe there is a path for EXLS to beat its guidance. Importantly, despite the challenging macro environment, EXLS continues to execute well and sees no material decline in demand. Aside that, I also expect EXLS to increase margins this year. To sum up, I think EXLS's underlying growth is still strong, and that, combined with the possibility of margin expansion, will boost investor confidence resulting in a positive narrative for the share price. Organically, EXLS analytics features should remain to be a top priority for customers. Together, this and the recurring nature of EXLS's BPO work should make the company more resistant to the effects of a weak macro environment.

4Q22 results

In 4Q22, revenue came in 4% higher than expected, and guidance for FY23 revenue growth of 11-14% excluding FX impact was in line with street expectations. It seems to me that the guidance doesn't set an especially high bar for this year, especially in light of the robust growth EXLS has been experiencing. In details, 4Q22 saw an increase of over 20% in the field of operations management thanks to buoyant tendencies in Emerging Businesses and moderate decline rates in Healthcare. The growth of analytics was relatively stable, increasing 28% organically despite the challenging conditions.

Revenue growth

The main focus is on the Analytics capability of EXLS, which was the driving force behind its growth. Over the past two years, the Analytics segment has experienced strong growth and is expected to continue its growth trajectory in 2023, with a sequential growth of 3% in the fourth quarter and an estimated mid-to-high teens growth for FY23. In addition, the integration of Analytics-related work within larger Digital Operations deals has also contributed to the impressive growth of Digital Operations. For context, EXLS now competes for larger deals, and its backlog entering this year is seen as a crucial factor to keep an eye on, as it could provide better insight into the company's growth momentum.

Margins

Investments in client ramp ups and persistent high wage inflation led to lower-than-expected margins in 4Q22. Still, EXLS was able to improve its margin by 100bps due to the fact that its operating expenses decreased as a percentage of revenue (which can be seen as operating leverage in effect). Regarding the potential for EXLS to increase its margins organically, I believe EXLS will see positive mix shift impact from a higher mix of Analytics. Additionally, by improving its efficiency and streamlining its operations, EXLS should be able to reduce its costs and further enhance its margins. Indeed, management's FY23 outlook suggests a modest y/y margin expansion, which is in line with expectations. Additionally, I like EXLS capital allocation strategy which is in line with improving shareholder value by driving EPS growth through buybacks and value accretive deals.

Outlook

I anticipate that EXLS will continue to see robust demand for its services as businesses seek to counteract the effects of the current economic downturn through initiatives to cut costs and enhance operational efficiencies. I like to highlight that EXLS relies heavily on annuity-based work, which typically lasts for four to five years and generates a very visible revenue stream. This also means that management should have a relatively high confidence in guiding numbers. While the remaining revenue is on a project basis which is a lot more volatile, I think management FY23 guidance is quite conservative as it is half the growth rate of recent quarters. Also, there is a potential for an economic slowdown in 2H23. Overall, I think that the initial FY23 guidance could be exceeded due to the greater push for global businesses to improve their operational efficiencies.

Conclusion

In conclusion, based on the strong 4Q22 results and management's guidance for FY23 revenue growth, I recommend a buy rating for EXLS stock. With a focus on its Analytics capability, which has been the driving force behind its growth, and the integration of Analytics-related work within larger Digital Operations deals, EXLS is well-positioned to continue its growth trajectory in 2023. I also expect EXLS to increase its margins this year thanks to increased efficiency and incremental pricing leverage on higher value analytics work. Moreover, EXLS's capital allocation strategy, which prioritizes shareholder value through buybacks and value accretive deals, is another positive factor. Overall, EXLS's annuity-based work and sustained backlog make it a resistant company in a weak macro environment. While there is a potential for an economic slowdown in 2H23, I believe there is upside potential to the initial FY23 guidance due to the increasing push for businesses to drive greater operational efficiencies.