Persistent Systems: Future growth at the cost of margins

Continuous investments could pull down margins, say analysts

Persistent Systems maintained its dollar revenue growth forecast of 15 per cent for FY15 and said it expected sequential growth of 3.5–6.1 per cent in the December quarter and 6.2–11.4 per cent in the March 2015 quarter. The management commentary at the company’s annual analyst day comes at a time when most information technology  biggies are trimming their revenue growth outlook. Not surprisingly, the scrip made a new 52-week high of Rs 1,672.65 recently. The company identified enterprise digital transformation as the next growth driver and plans to make necessary investments in this segment, even if it puts margins under pressure. “Persistent's margins might disappoint, as it continues to invest in domain capabilities. Moreover, Persistent is making sure there are no skill shortages that could impact growth,” says Ashish Aggarwal of Antique Stock Broking. Analysts expect Persistent's Ebitda (earnings before interest, tax, depreciation and amortisation) margin to fall 338 basis points to 22.4 per cent in FY15 as compared to FY14 and witnessed a marginal uptick of 105 basis points to 23.5 per cent in FY16.

In sync with the changing demand scenario, Persistent has stepped up investments in sales and domain expertise in the EDT segment. According to Zinnov Management Consulting, enterprise digital spends are expected to grow at compounded annual growth rate of 26 per cent to $230 billion in 2020 from $70 billion in 2015. Persistent expects intellectual property-led revenue growth to moderate and believes continuous acquisitions are essential to push in this segment. Acquisitions will enable Persistent to cross-sell its services to new customers and ensure higher mining of clients and improved visibility.

Persistent’s presence in most of the new high-growth technologies (cloud computing, analytics, collaboration and mobility) reduces the risk of obsolescence and long-term relationships with reputed clients lends comfort on sustainable growth. Its key strength is focus on agile product development.

The scrip has outperformed the BSE Sensex in the past month. Analysts believe it seems fairly valued for now. “Based on the business model, financial performance and execution thus far, Persistent’s premium valuation to peers is justified in our view. However, at 16.5 times the FY16 estimated earnings, risks to execution outweigh the rewards. Our target price of Rs 1,650 discounts FY17 EPS by 14 times, which implies three per cent upside,” believes Ashish Chopra of Motilal Oswal Securities.