CMP: INR912 TP: INR1,200(+32%) Buy

Transcription

1 25 January QFY17 Results Update Sector: Technology Zensar Technologies BSE SENSEX S&P CNX 27,708 8,603 Bloomberg ZENT IN Equity Shares (m) 45 M.Cap.(INRb)/(USDb) 40.9 / Week Range (INR) 1136 / 805 1, 6, 12 Rel. Per (%) -10/-11/-16 Avg. Val, INR m 37 Free float (%) 51.4 Financials & Valuations (INR b) Y/E Mar E 2018E Net Sales EBITDA PAT EPS (INR) Gr. (%) BV/Sh (INR) RoE (%) RoCE (%) P/E (x) P/BV (x) Estimate change TP change Rating change CMP: INR912 TP: INR1,200(+32%) Buy Strategy execution validated by strong deal wins and gains getting aggressively reinvested into the business In-line revenue growth : 3QFY17 revenue growth of 1.9% QoQ was largely in line with our estimate of +2.1% QoQ. This included USD2m revenue from the acquisition of Foolproof (two months). Excluding this, growth would have been flat (also as expected). Organic revenue was largely driven by [1] IM, which grew 3.7% QoQ led by traction in Services and [2] Digital (30% of total revenue), while seasonality weighed on top clients performance. but deal wins continue to impress: Deal wins TCV in 3QFY17 was at USD170m, a sharp acceleration from USD130m in the previous quarter. The jump is an encouraging sign of the success ZENT has started seeing in large deals (USD10m+), which totaled USD127m. ZENT recently launched The Vinci (an automation and orchestration platform), which along with Digital, has been playing a crucial role in achieving win ratios of ~40% in large deals. Investments to keep profitability in a range: EBITDA margin contracted 30bp QoQ to 13.8% (est. of 14.2%), despite GPM expansion of 30bp. Benefits from improved business mix and efficiency gains were ploughed back into the business. Several senior hires, augmentation of sales/marketing, and investments in capabilities took precedence. PAT at INR811m (+18.1% QoQ) was a tad lower than our expectation of INR820m. Strategy execution fast-paced: We are moderating our margin expectations following the upshift in investments in the form of senior hires and capability building initiatives. While potential margin uptick from levers such as improvement in IMS profitability is higher, we model margin expansion of 80bp (120bp earlier) over FY17-19E. We cut our EPS by 8/6% for FY18E/19E. Maintain Buy with a revised TP of INR1,200, discounting FY19E EPS by 13x. Quarterly Performance (Consolidated) Sagar Lele (Sagar.Lele@MotilalOswal.com); Ashish Chopra (Ashish.Chopra@MotilalOswal.com); Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal Oswal research is available on Bloomberg, Thomson Reuters, Factset and S&P Capital.

2 3QFY17: Revenue growth at 2.1% QoQ CC ZENT s 3QFY17 revenue grew 1.9% QoQ CC, largely in line with our estimate of 2.1% QoQ CC growth. In USD terms, revenue grew by 1.3% QoQ to USD118m, in line with expectations (exp: 1.6% QoQ to USD118m). The quarter also included two months of revenue from the acquisition of Foolproof, which added USD2m. Excluding this, growth was flat in the organic business, weighed upon by seasonality. In Rupee terms, revenue was INR7,922m, up 2.0% QoQ, v/s our estimate of INR7,954m (2.4% QoQ). Exhibit 1: Revenue growth in line with expectations Revenue (USDm) Growth (QoQ, %) (1.4) (3.7) (8.8) Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Margin benefits ploughed back into the business Gross margin expanded 30bp QoQ to 30% (estimate of 29.6%). However, EBITDA margin was down 30bp QoQ to 13.8% (estimate of flat margins at 14.1%). Margins expanded at a gross level on account of better operational efficiencies and changing business mix. However, SGA was higher by 60bp higher at 16.2% of revenue, weighing operational profitability lower. Exhibit 2: EBITDA margins lower because of increased SGA EBITDA margin (%) SG&A (%) Exhibit 3: Blended utilization steady at around 80% Utilization (%) 82% 81% 80% 80% 80% 80% 79% 79% 79% 78% 78% 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 25 January

3 Exhibit 4: Profitability resurrection - a dire need in the IM business Application services EBIT margin (%) Infrastructure Management EBIT margin (%) (4.7) QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 Other income was at INR183m in 3Q, versus our estimate of INR186m. Effective tax rate during the quarter was 29.1% (estimate of 28%). Consequently, PAT grew by 18.1% QoQ to INR811m, against our expectation of INR820m (+19.4% QoQ). Segment-wise performance: Strong growth in Europe, Africa and Financial Services Growth in key geographies: Growth was driven by Europe (30.2% QoQ CC), driven by the acquisition of Foolproof, and Africa (8.1% QoQ CC). While US was flat, ROW declined by 31% QoQ CC. Growth in key verticals: Growth during the quarter was largely led by Financial Services (9.7% QoQ CC). Growth in Manufacturing was 1.4% QoQ CC, and that in Retail and Consumer Services was 0.7% QoQ CC. Emerging verticals saw a decline of 18.9% QoQ CC. Growth was higher in IMS (3.7% QoQ), while Application Services grew by 0.6% QoQ. Exhibit 5: Strong growth in Financial Services Contribution QoQ YoY Manufacturing Retail and consumer services Financial services Emerging Exhibit 6: Growth driven by Infrastructure Management Contribution QoQ YoY Application Management Services Infrastructure Management Services Maintenance Services Exhibit 7: Growth dominated by Europe and Africa Contribution QoQ YoY USA Europe ROW January

4 Recovery metrics trending well The clean-up in business continued, visible from the aggressive cut down of lowyield and non-scalable customers. Gross client addition was 41, while net clients added were 28 indicating pruning of 13 accounts. This is the fifth consecutive quarter of account pruning. Exhibit 8: Pruning of accounts to continue, client count in 3Q up on Foolproof acquisition Number of active customers Client attrition QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 The Services business in Infrastructure Management continued to grow well. While Maintenance revenue declined by 1.5% QoQ, Services revenue grew by 5.8% QoQ. Exhibit 9: IM business restructuring well in progress Maintenance Services 19% 2% 4% 4% -2% -16% -13% -15% -17% -21% -8% -18% -15% -4% 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 Takeaways from management commentary Strong deal wins during the quarter: Deal signings picked up as the company won deals worth USD170m, compared to USD130m in the previous quarter. This pick-up was aided by large deal wins of USD127m. The focus on this area has started bearing fruit, and the company is seeing healthy win rates, winning against MNC and IOP Tier-I competition. Launched The Vinvi : Recently ZENT launched its own automation platform The Vinci and it has been seeing a good response and differentiated positioning. It is already deployed at ~6 customers; and has helped automate 40-50% of typical L1/L2 requirements. It has also been instrumental in winning some of the large deals bagged during the quarter. 25 January

5 Investments to continue: Several investments were made during the quarter in the form of senior leadership, sales and marketing headcount and capability building. New leadership hires in the quarter include the head of sales for the US, head of enterprise application delivery and head of digital commerce. The team is still getting built and investments are likely to continue in the coming quarters. Margins likely to remain in a band: While the company is able to save margins at a gross level on account of a changing business mix and because of improvement in operational efficiencies, investments are being ramped up. This is likely to keep the margin trend similar to what was in the last twelve months. There are, however, several levers in the longer term including pyramid rationalization, automation and leverage on account of revival of revenue growth. Factoring in re-investments, tapering margin expansion expectations While revenue growth in 3Q was in line with expectations, and deal wins provide confidence in growth rate acceleration going forward, the pruning of accounts has lasted longer than expectations. RoW during the quarter was down 31% QoQ CC and Emerging verticals were down 19% QoQ CC. Because of this we have reduced our revenue assumptions for FY18/19E by 2.1/2.9%. We now expect revenue growth of 11/12% respectively, compared to 13% earlier. The company has multiple levers for margin expansion the largest being revival of revenue growth, and change in business mix. The change in mix alone has the potential to contribute to ~200bp expansion over the next two years. However, investing in the business to execute strategy has taken precedence; clear from the plugging-back of saving in gross margins into the business. On account of this approach, we have made tepid our margin expansion estimates. We now expect cumulative expansion of 80bp in margins over the next two years, compared to 120bp earlier. Consequently, our earnings estimate for FY18/19E has reduced by 8/6%. Exhibit 10: Change in estimates Revised Earlier Change FY17E FY18E FY19E FY17E FY18E FY19E FY17E FY18E FY19E INR/USD Revenue (USDm) (0.3) (2.1) (2.9) Growth (YoY, %) (27) (205) (97) EBITDA margin (%) (3) (110) (44) EPS (INR) (1.3) (8.1) (5.9) 25 January

6 Valuation and view Execution for next leg of growth is in progress: Post the leadership change at ZENT, execution has become fast-tracked, with several steps taken toward realigning the organization with its growth engines. In line with this, several services/solutions have been launched, sales function has been augmented and there is a renewed focus on client mining and large deals. These initiatives are currently in the investment mode and likely to start adding to growth along with Digital and IMS. Digital; the key trigger: Digital accounts for 30% of ZENT's revenue and has been seeing growth of 21-37% YoY. Half of Digital is constituted by ecommerce implementation, where capabilities have increased post ZENT's acquisition of Professional Access, which in FY16 grew by 25% YoY. The rest of Digital revenue comes from other Digital and cross-over services. Moreover, with increased emphasis on Enterprise Digital and CMO-led solutions, Digital will only get a further boost from current levels. Re-constitution to continue for the better: ZENT had earlier laid focus on achieving the Diamond partnership with Oracle. However, elevation from Platinum partnership is a function of the work around Oracle's installed base, and not cloud services. Oracle has a managed cloud partner program, on which ZENT has turned its attention as this better aligns with changing market dynamics, Oracle's strategy and ZENT's focus areas. Moreover, the realignment of focus in infrastructure management toward IMS & Cloud too marks a step in this direction. Aggressive consolidation of non-core business: Over the last two years, ZENT has cut out non-core geographies, verticals and service lines. Since the leadership change, the company has renewed focus on strategic accounts, and is in the process of cutting its long tail of low-yield and non-scalable accounts. Pruning of these accounts has been on-going for the last five quarters, and is expected to continue for one more. Expect rebound in revenue growth: On account of ongoing restructuring, we expect revenue growth of 3.4% in FY17. However, with the implementation of growth engines well in progress, we expect a revival in revenue growth to 10/12% in FY18/19. Margin comfort for FY17-19E: Revenue growth pick-up, profitability improvement in the IMS business, and current investments should lead to a 80bp EBITDA margin expansion over FY17-19E. EBIT margins in the IMS business (22% of revenue) can improve from 6% in FY16 to 14% in FY18, led by higher revenues from 'IMS and Cloud' and the restructuring in the MVS business. This alone has the potential to improve overall margins by 150bp. However, we are being conservative on our expansion assumptions (compared to earlier) as investments have picked up. Valuing the stock at 13x FY19E earnings, we maintain our BUY rating on the stock with a price target of INR1,200. Key triggers Broad-based pick-up in revenue growth Margin improvement despite investments Significant increase in deal wins and deal pipeline 25 January

7 Key risk factors Problems in top accounts Risk from slower spend on ERP Hindrances in structural recovery of margins Exhibit 11: 1-year forward PE band PE (x) Peak(x) Avg(x) 20 Median(x) Min(x) Exhibit 12: 1-year forward PB band PB (x) Peak(x) Avg(x) 4.0 Median(x) Min(x) Jan-07 Apr-08 Jul-09 Oct-10 Jan-12 Apr-13 Jul-14 Oct-15 Jan-17 Jan-07 Apr-08 Jul-09 Oct-10 Jan-12 Apr-13 Jul-14 Oct-15 Jan January

8 Story in charts Exhibit 13: Contribution of Digital to total revenue among the highest in the industry (FY16) Exhibit 14: 21-37% YoY growth in all areas of Digital in FY16 Digital revenue (USDm) Digital (% of total revenue) 36% 30% 27% 5 FY16 Growth (YoY, %) % 17% 15% 12% 2,154 1, TCS WPRO MTCL ZENT PSYS NITEC KPIT Company Big data & analytics Cloud Design experience Digital marketing services B2C Commerce B2B Commerce Cyber security Exhibit 15: Expect revenue growth to pick-up Exhibit 16: coupled with margin expansion 4.9 Revenue (USDm) Growth (YoY, %) EBITDA margin (%) (1.7) FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Exhibit 17: Assisted by portfolio reconstitution Exhibit 18: Potential for improvement in IMS margins Maintenance Services 2% 4% 4% 19% IMS revenue (INRb) IMS PBIT margin (%) % -8% -4% -16% -13% -15% -17% -21% -18% -15% 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY FY13 FY14 FY15 FY16 25 January

9 Operating metrics Exhibit 19: Operating metrics 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 Geographic Mix (%) USA Europe ROW Vertical Mix (%) Manufacturing Retail and consumer services Financial services Emerging Service Mix (%) Application Management Services Infrastructure Management Services Maintenance Services Project Type (%) Fixed price Time & material Revenue by delivery (%) Onsite Offshore Client metrics Client concentration (%) Top Top Top Top Top Client brackets 1 Million dollar Million dollar Million dollar Million dollar Other metrics Repeat business (%) Number of active clients New clients added in the period Employee metrics Total headcount 8,037 8,174 7,895 8,050 8,192 8,256 8,238 8,316 8,564 Gross employees added during the period , Net employees added during the period (279) (18) Utilization Attrition Source: Company, MOSL 25 January

10 Financials and Valuations Key assumption E 2018E 2019E INR/USD Rate Revenues (USD m) Offshore Revenue (%) Total Headcount 7,121 6,508 6,791 8,174 8,256 8,564 9,274 10,214 Net Addition 976 (613) 283 1, Per Capita Productivity (USD) 52,103 59,805 56,364 52,574 54,850 54,668 55,995 56,979 Income Statement (INR Million) Y/E Mar E 2018E 2019E Net Sales 17,825 21,145 23,156 26,277 29,643 31,519 36,332 40,971 Change (%) EBITDA 2,263 2,892 3,396 3,641 4,262 4,480 5,379 6,130 EBITDA Margin (%) Depreciation EBIT 1,930 2,561 3,013 3,226 3,808 4,039 4,870 5,556 Interest Other Income Extraordinary items PBT 2,364 2,606 3,399 3,659 4,289 4,403 5,357 5,878 Tax ,023 1,013 1,169 1,274 1,500 1,646 Tax Rate (%) Min. Int. & Assoc. Share Reported PAT 1,587 1,745 2,375 2,646 3,094 3,096 3,837 4,212 Adjusted PAT 1,587 1,745 2,375 2,646 3,094 3,096 3,837 4,212 Change (%) Balance Sheet (INR Million) Y/E Mar E 2018E 2019E Share Capital Reserves 5,325 6,853 9,017 11,127 13,812 16,204 19,247 22,509 Net Worth 5,759 7,289 9,455 11,570 14,258 16,650 19,693 22,955 Debt 2,755 2,353 2,032 1,396 1,878 1,628 1,378 1,128 Deferred Tax Total Capital Employed 8,514 9,642 11,498 12,977 16,175 18,317 21,110 24,122 Gross Fixed Assets 6,045 6,341 6,503 8,201 8,889 9,889 10,339 10,789 Less: Acc Depreciation 2,269 2,372 2,287 2,728 3,182 3,623 4,132 4,705 Net Fixed Assets 3,776 3,969 4,215 5,474 5,706 6,265 6,207 6,083 Capital WIP Investments , ,016 1,116 1,216 1,316 Current Assets 7,984 8,162 9,145 10,926 13,490 16,479 20,039 23,878 Inventory 950 1,049 1,288 1,226 1,259 1,295 1,294 1,347 Debtors 2,911 3,354 3,581 4,539 5,427 6,045 6,968 7,858 Cash & Bank 1,745 1,420 1,458 1,960 2,823 3,648 5,714 7,971 Loans & Adv, Others 2,379 2,339 2,818 3,201 3,980 5,492 6,064 6,702 Curr Liabs & Provns 3,741 2,931 3,361 4,368 4,054 5,556 6,360 7,159 Curr. Liabilities 3,221 2,615 2,893 3,731 3,761 5,186 5,936 6,682 Provisions Net Current Assets 4,243 5,231 5,784 6,558 9,436 10,923 13,679 16,719 Total Assets 8,514 9,642 11,498 12,977 16,175 18,317 21,110 24, January

11 Financials and Valuations Ratios Y/E Mar E 2018E 2019E Basic (INR) EPS Cash EPS Book Value DPS Payout (incl. Div. Tax.) Valuation(x) P/E Price / Book Value EV/Sales EV/EBITDA Dividend Yield (%) Profitability Ratios (%) RoE RoCE RoIC Turnover Ratios (%) Debtors (No. of Days) Inventory (No. of Days) Creditors (No. of Days) Leverage Ratios (%) Net Debt/Equity (x) Cash Flow Statement (INR Million) Y/E Mar E 2018E 2019E Adjusted EBITDA 2,263 2,892 3,396 3,641 4,262 4,480 5,379 6,130 Non cash opr. exp (inc) (Inc)/Dec in Wkg. Cap , , Tax Paid , ,046-1,274-1,500-1,646 Other operating activities CF from Op. Activity 1,735 1,060 2,094 3,206 2,587 4,071 3,744 4,071 (Inc)/Dec in FA & CWIP Free cash flows 1, ,771 2,834 2,164 3,075 3,298 3,625 (Pur)/Sale of Invt , , Others CF from Inv. Activity ,284-1, , Inc/(Dec) in Net Worth Inc / (Dec) in Debt Interest Paid Divd Paid (incl Tax) & Others CF from Fin. Activity , ,302-1,045-1,130-1,266 Inc/(Dec) in Cash ,066 2,257 Add: Opening Balance 1,096 1,739 1,413 1,448 1,960 2,823 3,648 5,714 Closing Balance 1,745 1,420 1,458 1,960 2,823 3,648 5,714 7, January

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