Hexaware: Skewed picture

Focus on few clients to put pressure on gross margins

Hexaware's focus on the human resource (HR) infotech services practice has paid off handsomely this year. In the nine months till September 2004, its revenues have grown 64.6 per cent and, more importantly, operating profit has jumped by 167.5 per cent.

In the September quarter, revenues grew 13.9 per cent sequentially, while operating profit rose significantly by 42.4 per cent.

Margin expansion continued to come from savings on selling, general and administration (SG&A) expenses. Last quarter, SG&A fell further by 260 basis points as a percentage of sales, after a 160 basis points drop in the June quarter.

However, these expenses still account for 21.5 per cent of revenues (much higher than industry), which means there's room for more improvement.

While this may help driving earnings growth in 2005 as well, the key driver is expected to be revenue growth. Last quarter, Hexaware won new orders worth $30 million, and about 60 per cent of that will be executed in 2005.

Further, one of the company's largest clients, Exult, was taken over by Hewitt Associates last quarter. The company said the engagements with Exult will continue, while there could be new engagements with Hewitt, which is a much larger player in the HR outsourcing space. Analysts are already factoring in a growth of over 70 per cent for 2005.

Based on CY05 estimates, the stock gets a valuation of around 12, which seems inexpensive given the high growth rates expected going forward. But at the same time the stock is not expected to make significant gains from current levels especially with the future of Peoplesoft (Hexaware's forte is implementing Peoplesoft) still not clear.

Also, the company's dependence on a top few clients (the top 5 account for over 41 per cent of revenues) has resulted in pressure on offshore billing rates, which have fallen 6.7 per cent in the space of three quarters. If the trend continues, gross margins could come under pressure.

ECBs and FCCBs

Reliance Infocomm has just raised $300 million in a syndicated term loan facility offshore and is in the process of tying up another $500 million. This is just the continuation of a trend in external commercial borrowings (ECBs) whereby companies are taking advantage of the lower interest rates overseas.

ECBs for H105 are at over $5 billion compared with $3.3 billion in the corresponding period last year. Many have used the foreign currency convertible bonds (FCCB) route as well, giving lenders an option to own equity. FCCBs worth $1.5 billion are estimated to have mobilised in the last six-odd months.

The capex cycle is ostensibly on the upswing. CMIE data show total planned investment by private and public sectors over the next four years at about Rs 7 lakh crore, including current investments.

So how big is the opportunity for domestic lenders? With ECBs the flavour of the season, the local demand may not be as high as envisaged some time back, given that many companies are fundamentally stronger and therefore throwing up huge amounts of cash.

What this could mean is that it would leave enough liquidity with lenders, even if deposits are growing at a lower rate this year (incremental deposit flows between April and mid-Sept were around Rs 81,000 crore compared with Rs 94,800 crore last year).

So there might not be as sharp a spike in domestic interest rates as had been anticipated. And that is not such a bad thing for borrowers.

Ranbaxy-in the pink of health

Ranbaxy's consolidated profit before extraordinary items has grown 8.7 per cent to Rs 265.4 crore in the last quarter, while sales have grown 19 per cent to Rs 1343.9 crore.

Profit growth has been lower than sales growth owing to a number of reasons - foreign exchange gains have shrunk by around 87 per cent, while interest costs have doubled to Rs 12.7 crore in the last quarter owing to expanding manufacturing facilities.

European sales recorded a growth of 91 per cent to reach $ 46 million in the last quarter helped by sales of products like Visclair (for treatment of chronic obstructive pulmonary disease).

Also Ranbaxy realised the benefits of the expanding French generics market in the last quarter via its recent acquisition of France - based RPG Aventis.

Meanwhile, in the US market sales grew 13 per cent to $102 million. Cefuroxime Axetil (an anti-infective) faced continued pricing pressure in the American market but the company has expanded sales of other products such as Riomet and Sortret. And in the domestic markets, sales growth were with the broader home market growth of around 4-5 per cent.

Higher sales helped operating profit (excluding other operating income) grow 56 per cent to Rs 278.4 crore and operating profit margins rose 500 basis points to 21 per cent.

The company had received 7 ANDA approvals in Q3 and cumulative filings reached 127 ANDAs, indicating a healthy molecule pipeline which the company is expected to leverage by aggressive launches in the medium and that should help drive profits going forward.

With contributions from Mobis Philipose, Shobhana Subramanian and Amriteshwar Mathur