Midcap IT: Hexaware, Polaris set to shine through

Give robust guidance for the year, while client-specific issues continue to hit Sasken & MindTree.

The March quarter results posted by midcap information technology (IT) companies were a mixed bag. While Hexaware Technologies, Polaris Software and Firstsource (FSL) posted good results, Mindtree and Sasken Communications were bogged by client-specific issues.

Going ahead, FSL and Polaris are expected to clock higher revenue growth on the back of robust banking, financial services and insurance (BFSI) demand. Further, Hexaware is best placed to gain from the uptick in discretionary spending, which forms 42 per cent of its revenues. Though Mindtree’s research and development segment continues to be a drag, growth in IT services is healthy.

Hexaware and Polaris expect strong revenue growth, of 27.5 per cent and 22-25 per cent, respectively, for the year. They’re also confident of sustaining margins at current levels. The FSL management commented on increased momentum in revenue growth and expects margin expansion to continue. The MindTree management was confident of 2011-12 revenue growth at 16-18 per cent.

PROSPECTS
Hexaware will be a key beneficiary from recovery in discretionary spending. Analysts believe it will be able to maintain Ebitda (earnings before interest, taxes, depreciation and amortisation) margins of 14-15 per cent in calendar years 2011 and 2012 and have raised earnings estimates for the period by 24-26 per cent. Though business momentum remains strong, the stock has doubled in the past year, capping further upsides.

Polaris will gain significantly from a robust 40 per cent annual growth of its flagship product, Intellect, as well as from higher traction in the BFSI segment. Its recent acquisition, IdenTrust, will add $11-13 million in 2011-12, as well as in 2012-13. Operating margins will be under pressure in 2011-12 due to pay rises and investment in IdenTrust. The stock is trading at 8.1 times FY13 estimated earnings, which is at a steep discount to peers. Thus, it is a preferred pick by most brokerages among mid-tier IT stocks.

In contrast, boosting revenue growth is the key challenge for Sasken. The company derives 90 per cent of revenue from the telecom sector, which is yet to witness demand pick-up. Its diversification in emerging technologies like android and segments like automotive will bear fruit only in the longer term.
 

HEALTHY TOP LINE GROWTH
In Rs crore	Polaris	Hexaware	Sasken	Mindtree	Patni	Firstsource
Net revenues	438	319	129	391	848	546
% chg q-o-q	9.4	6.3	-7.1	1.7	3.4	6.2
Ebitda (%)	12.0	14.3	13.3	11.2	16.1	14.5
Chg in bps q-o-q	-106	280	-617	-50	10	678
Net profit	58	54	19	32	118	25
% chg q-o-q	15.7	35.9	19.4	4.9	-33.1	15.2
EPS (Rs)	5.9	1.8	6.5	7.8	9.0	0.8
All figures are for the quarter-ended March 31, 2011                                                                    Source: Companies

 

MARGIN PRESSURE AHEAD
In Rs crore	Polaris	Hexaware*	Sasken	Mindtree	Patni*	Firstsource
Sales	1,907	1,355	583	1,780	3,594	2,268
% chg y-o-y	22.0	30.2	2.4	17.5	12.7	10.6
Ebitda (%)	13.9	13.1	17.9	14.4	18.8	14.3
Chg in bps	-29	436	-223	154	-73	9
Net profit	207	176	69	155	520	140
% chg y-o-y	5.2	63.4	-7.4	41.3	-5.1	16.4
P/E (x)	9.8	11.4	6.6	9.4	9.9	6.4
All figures are FY12/CY11 estimates * Year ending 31st December                                               Source: Bloomberg

Given the stable business profile of BPOs and steady performance of FSL, analysts believe current valuations are compelling. FSL’s Asian business (11 per cent of revenues) and utilisation rates would be key drivers of margin expansion in FY12. The management’s undeterred focus on IT services business and not on products will enable MindTree to improve execution in FY12. Analysts believe higher trainee intake and increase in operating leverage will drive operating margin expansion of 200-220 basis points in FY12.

The merger with iGate will drive growth for Patni, helping the company save to the tune of $30 million. However, margins will continue to be under pressure. Higher tax rates, as well as high dependence on the application development domain and the US market, are key pressure points.

VOLUME, MARGINS
While volume growth was strong at four-five per cent, quarter-on-quarter, for most, Mindtree and Sasken struggled to grow due to client-specific issues. A ramp-down of the Kyocera account cost MindTree $2.5 million in revenue, along with a one per cent drop in realisations and a 50-basis points hit on the margin. Sasken was hit by a 60 per cent drop in product revenues and continued order slowdown from top clients.

Core operating margin (excluding one-off items) improved for major players. FSL’s margin expansion came in largely from the Ebit breakeven achieved by its Asia business unit. Adjusting for Kyocera, the margins for MindTree would have increased by 130 basis points q-o-q to 13 per cent. While Patni’s margins were largely stable at 16 per cent, Hexaware saw an improvement to 14.3 per cent, driven by higher utilisations, greater offshore shift, better pricing and currency gains. Polaris’ margins eroded due to higher travelling cost, escalated by the crisis in Japan. Excluding Japan and the West Asian crisis, the margin decline was 37 bps. Meanwhile, a revenue decline, coupled with falling utilisation, shrunk Sasken’s Ebitda margin. The bottom line of most companies was a function of forex gains/losses and the tax rates. However for Polaris, monetisation of real assets boosted other income, thereby aiding bottom line growth.