Company Update Impact of Macro Headwinds Still Hurting; Revenue from US May Pick up in FY18E EBITDA Margins recovered by 618 bps QoQ: The company has witnessed many challenges over the year FY17 starting with Brexit which has an impact on depreciation of British Pound which took significant hit to ~25% of business from UK during the year. However, the company is trying to recover from the rough phase as SQS recorded revenue of Rs. 607 Mn in Q1FY18 with a rise of 5.6% QoQ. EBITDA margins for Q1FY18 are at 20.3% which is up by 618 bps QoQ. PAT stood at Rs. 90 Mn vis-a-vis Rs. 45 Mn QoQ with an increase of 100%. Revenue from Europe increased by 13.8% QoQ: Revenue from Europe has increased to Rs. 371 Mn in Q1FY18 with a growth of 13.8% QoQ through increased revenue from a large customer in Spain, as well as revenue from new customers in DACH region (Austria, Switzerland and Germany). It has been a period of progress across the business with having a stronger pipeline and also increasing the revenue from digital offerings. Revenue from US may pick up in FY18E: As US is the largest market for software testing, SQS has started stretching its business in US. In Q1FY18, revenue from US stood at Rs. 60 Mn with an increase of 10.0% QoQ. The company has invested more in the US in terms of marketing capacity, adding skilled staff which helps to improve new customer acquisition. Revenue by segment, Cards & Payments stood at Rs. 239 Mn with a growth of 28.0% QoQ which is due to increased revenue from the large customer from Spain and also from other customers in multiple geographies. We are marginally re-estimating the total revenue to Rs. 2798 mn and Rs. 3149 mn for FY18E & FY19E respectively. We expect EBITDA margins could be in a range of ~16%-17% in FY18E & FY19E and we estimated PAT margins at 10-11%. Valuation and Outlook At CMP of Rs. 500, the stock is trading at FY19E P/E of 16.8x; we give a HOLD recommendation with a revised target price of Rs.566 per share at P/E of 19.0x to FY19E EPS, which represents an upside potential of 13%. Key Risks yforeign exchange rate fluctuations. yuncertainties in economic, business and geo-political conditions. yfinancial services domain risk. Exhibit 1: Valuation Summary (Rs. Mn) Information Technology-Software & Services Bloomberg Code: SQSI IN India Research - Stock Broking Net Sales 2142 2642 2599 2798 3149 EBITDA 371 541 408 464 542 EBITDA Margin (%) 17.3 20.5 15.7 16.6 17.2 Adj. Net Profit 216 369 231 270 318 EPS (Rs.) 20.9 34.9 21.6 25.3 29.8 RoE (%) 20.6 35.0 19.6 20.6 22.8 PE (x) 27.4 26.1 25.3 19.8 16.8 ; *Represents multiples for FY15, FY16 & FY17 are based on historic market price For private circulation only. For important information about Karvy s rating system and other disclosures refer to the end of this material. Karvy Stock Broking Research is also available on Bloomberg, KRVY<GO>, Thomson Publishers & Reuters Recommendation (Rs.) Aug 07, 2017 CMP (as on Aug 07, 2017) 500 Target Price 566 Previous Target Price 631 Upside (%) 13 Stock Information Mkt Cap (Rs.mn/US$ mn) 5397 / 85 52-wk High/Low (Rs.) 967 / 489 3M Avg. daily volume 10995 Beta (x) 0.7 Sensex/Nifty 32274 / 10057 O/S Shares(mn) 10.7 Face Value (Rs.) 10.0 Shareholding Pattern (%) Promoters 53.9 FIIs 1.3 DIIs 1.9 Others 42.9 Stock Performance (%) 1M 3M 6M 12M Absolute (4) (6) (20) (43) Relative to Sensex (8) (13) (30) (51) Source: Bloomberg Relative Performance* 130 110 90 70 50 Aug-16 Sep-16 Oct-16 Nov-16 Source: Bloomberg; *Index 100 Earnings Revision (%) YE Mar FY18E FY19E Sales (%) L L (2.4) L L (4.8) EBITDA (%) L L (1.5) L L (9.5) PAT (%) L L (1.5) L L(10.3) Source: Karvy Research Analyst Contact Prasanth Victor 040-3321 6271 Dec-16 Jan-17 v.prasanth@karvy.com Feb-17 Mar-17 Apr-17 May-17 HOLD Jun-17 Jul-17 Sensex Aug-17 1
Exhibit 2: Q1FY18 Aug 07, 2017 YE Mar (Rs. Mn) Q1FY18 Q4FY17 QoQ % Q1FY17 YoY % Turnover 607 575 5.6 731 (17.0) Expenditure 484 494 (2.0) 579 (16.4) EBITDA 123 81 51.9 152 (19.1) Depreciation 14 14 0.0 10 40.0 Interest 0 1 (100.0) 1 (100.0) Other Income 32 2 1500 4 700.0 PBT 141 68 107.4 145 (2.8) Tax 51 23 121.7 54 (5.6) PAT 90 45 100.0 91 (1.1) EBITDA Margin (%) 20.3 14.1 618 bps 20.8 (53) bps EBIT Margin (%) 18.0 11.7 630 bps 19.4 (147) bps Net Profit Margin (%) 14.8 7.8 700 bps 12.4 238 bps Exhibit 3: Segmental Financials (Rs. Mn) Q1FY18 Q4FY17 QoQ % Q1FY17 YoY % Revenue by Region Europe 371 326 13.8 417 (11.0) North America 60 55 10.0 75 (20.2) Asia 176 194 (9.4) 239 (26.4) Revenue by Segment Banking 215 244 (11.6) 346 (37.7) Capital Markets & Treasury 39 40 (3.5) 55 (29.1) Cards & Payments 239 186 28.0 260 (8.1) Insurance 114 105 9.0 71 60.9 Key Takeaways of Conference Call: ycapacity utilization improved to 73% compared to 61% during the last quarter. ysqs continues to take people who are domain experts and also certain number of entry level staff which helps to manage employee cost structure and overall margins. As on Q1FY18, employee count is at 857. ysqs continues to invest in the creation tools, accelerators and delivering the services as per changing customer requirements, which are getting more digital and agile in nature. ymanagement pointed that Asia is quite promising; there is more scope for growth in Asian market. Currently, business from Asia contributes 29.0%. ythe total revenue in Q1FY18 includes Rs. 19.7 Mn towards sale of Service Exports from India Scheme (SEIS) scrips. Exhibit 6: Change in Earnings Estimates YE Mar - Consolidated (Rs. Mn) FY18E FY19E Old New % Change Old New % Change Net Sales 2867 2798 (2.4) 3307 3149 (4.8) EBITDA 471 464 (1.5) 599 542 (9.5) EBITDA Margin (%) 16.4 16.6 (18) bps 18.1 17.2 89 bps Adj. PAT 274 270 (1.5) 354 318 (10.2) EPS (Rs.) 25.6 25.3 (1.2) 33.2 29.8 (10.3) Source: Karvy Research 2
Financials Exhibit 5: Income Statement Revenues 2142 2642 2599 2798 3149 Growth (%) 10.1 23.4 (1.6) 7.7 12.5 Operating Expenses 1770 2101 2191 2334 2607 EBITDA 371 541 408 464 542 Growth (%) (6.6) 45.7 (24.5) 13.7 16.8 Depreciation & Amortization 52 41 52 55 59 Other Income 18 65 7 6 6 EBIT 337 565 363 415 489 Interest Expenses 16 3 2 0 0 PBT 320 562 361 415 489 Tax 104 193 130 145 171 Adjusted PAT 216 369 231 270 318 Growth (%) (27.9) 70.4 (37.4) 16.8 17.8 Exhibit 6: Balance Sheet Cash & Equivalents 683 857 890 885 868 Sundry Debtors 567 544 425 570 792 Loans & Advances 113 145 91 203 238 Investments 4 5 3 3 3 Gross Block 483 526 597 634 671 Net Block 243 248 267 249 227 Others 26 21 14 28 7 Total Assets 1651 1819 1690 1938 2135 Current Liabilities & Provisions 560 728 418 589 700 Debt 73 0 0 0 0 Total Liabilities 633 728 418 589 700 Shareholders Equity 107 109 107 107 107 Reserves & Surplus 911 982 1165 1242 1328 Total Networth 1018 1091 1272 1349 1435 Total Networth & Liabilities 1651 1819 1690 1938 2135 3
Exhibit 7: Cash Flow Statement PBT 320 562 361 415 489 Depreciation 52 41 52 55 59 Interest 16 1 0 0 0 Tax Paid (102) (142) (142) (145) (171) Inc/dec in Net WC 35 123 84 (91) (99) Others 29 (7) 69 0 0 Cash flow from operating activities 351 577 424 234 278 Inc/dec in capital expenditure (28) 0 (57) (37) (37) Inc/dec in investments (21) (31) (71) 0 0 Others 20 138 6 (9) (26) Cash flow from investing activities (29) 107 (121) (46) (63) Inc/dec in borrowings (23) (96) 0 0 0 Issuance of equity 24 11 2 0 0 Dividend paid (98) (305) (308) (193) (232) Interest paid (15) (1) 0 0 0 Cash flow from financing activities (112) (391) (306) (193) (232) Net change in cash 209 292 (4) (5) (17) Exhibit 8: Key Ratios YE Mar FY15 FY16 FY17 FY18E FY19E EBITDA Margin (%) 17.3 20.5 15.7 16.6 17.2 EBIT Margin (%) 15.7 21.4 14.0 14.8 15.5 Net Profit Margin (%) 10.1 14.0 8.9 9.6 10.1 Dividend Payout Ratio (%) 114.8 68.9 111.1 71.3 73.9 Net Debt/Equity (x) (0.6) (0.8) (0.8) (0.7) (0.6) RoE (%) 20.6 35.0 19.6 20.6 22.8 RoCE (%) 29.7 51.8 30.7 31.7 35.1 Exhibit 9: Valuation Parameters YE Mar FY15 FY16 FY17 FY18E FY19E EPS (Rs.) 20.9 34.9 21.6 25.3 29.8 DPS (Rs.) 24.0 24.0 24.0 18.0 22.0 BVPS (Rs.) 96.5 102.5 119.0 126.2 134.3 PE (x) 27.4 26.1 25.3 19.8 16.8 P/BV (x) 5.9 10.6 4.6 4.0 3.7 EV/EBITDA (x) 14.6 16.3 12.1 9.6 8.3 EV/Sales (x) 2.5 3.3 1.9 1.6 1.4 ; *Represents multiples for FY15, FY16 & FY17 are based on historic market price 4
Stock Ratings Absolute Returns Buy : > 15% Hold : 5-15% Sell : <5% Connect & Discuss More at 1800 425 8283 (Toll Free) research@karvy.com Live Chat f in You Tube Disclaimer y Analyst certification: The following analyst(s), Prasanth Victor, who is (are) primarily responsible for this report and whose name(s) is/are mentioned therein, certify (ies) that the views expressed herein accurately reflect his (their) personal view(s) about the subject security (ies) and issuer(s) and that no part of his (their) compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report. y Disclaimer: Karvy Stock Broking Limited [KSBL] is registered as a research analyst with SEBI (Registration No INH200003265). KSBL is also a SEBI registered Stock Broker, Depository Participant, Portfolio Manager and also distributes financial products. The subsidiaries and group companies including associates of KSBL provide services as Registrars and Share Transfer Agents, Commodity Broker, Currency and forex broker, merchant banker and underwriter, Investment Advisory services, insurance repository services, financial consultancy and advisory services, realty services, data management, data analytics, market research, solar power, film distribution and production, profiling and related services. Therefore associates of KSBL are likely to have business relations with most of the companies whose securities are traded on the exchange platform. The information and views presented in this report are prepared by Karvy Stock Broking Limited and are subject to change without any notice. This report is based on information obtained from public sources, the respective corporate under coverage and sources believed to be reliable, but no independent verification has been made nor is its accuracy or completeness guaranteed. The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent of KSBL. While we would endeavor to update the information herein on a reasonable basis, KSBL is under no obligation to update or keep the information current. Also, there may be regulatory, compliance or other reasons that may prevent KSBL from doing so. The value and return on investment may vary because of changes in interest rates, foreign exchange rates or any other reason. This report and information herein is solely for informational purpose and shall not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments. Though disseminated to all the customers simultaneously, not all customers may receive this report at the same time. KSBL will not treat recipients as customers by virtue of their receiving this report. Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. This material is for personal information and we are not responsible for any loss incurred based upon it. The investments discussed or recommended in this report may not be suitable for all investors. Investors must make their own investment decisions based on their specific investment objectives and financial position and using such independent advice, as they believe necessary. While acting upon any information or analysis mentioned in this report, investors may please note that neither KSBL nor any associate companies of KSBL accepts any liability arising from the use of information and views mentioned in this report. Investors are advised to see Risk Disclosure Document to understand the risks associated before investing in the securities markets. Past performance is not necessarily a guide to future performance. Forward-looking statements are not predictions and may be subject to change without notice. Actual results may differ materially from those set forth in projections. y Associates of KSBL might have managed or co-managed public offering of securities for the subject company or might have been mandated by the subject company for any other assignment in the past twelve months. y Associates of KSBL might have received compensation from the subject company mentioned in the report during the period preceding twelve months from the date of this report for investment banking or merchant banking or brokerage services from the subject company in the past twelve months or for services rendered as Registrar and Share Transfer Agent, Commodity Broker, Currency and forex broker, merchant banker and underwriter, Investment Advisory services, insurance repository services, consultancy and advisory services, realty services, data processing, profiling and related services or in any other capacity. y KSBL encourages independence in research report preparation and strives to minimize conflict in preparation of research report. y Compensation of KSBL s Research Analyst(s) is not based on any specific merchant banking, investment banking or brokerage service transactions. y KSBL generally prohibits its analysts, persons reporting to analysts and their relatives from maintaining a financial interest in the securities or derivatives of any companies that the analysts cover. y KSBL or its associates collectively or Research Analysts do not own 1% or more of the equity securities of the Company mentioned in the report as of the last day of the month preceding the publication of the research report. y KSBL or its analysts did not receive any compensation or other benefits from the companies mentioned in the report or third party in connection with preparation of the research report and have no financial interest in the subject company mentioned in this report. y Accordingly, neither KSBL nor Research Analysts have any material conflict of interest at the time of publication of this report. y It is confirmed that KSBL and Research Analysts, primarily responsible for this report and whose name(s) is/ are mentioned therein of this report have not received any compensation from the subject company mentioned in the report in the preceding twelve months. y It is confirmed that Prasanth Victor, Research Analyst did not serve as an officer, director or employee of the companies mentioned in the report. y KSBL may have issued other reports that are inconsistent with and reach different conclusion from the information presented in this report. y Neither the Research Analysts nor KSBL have been engaged in market making activity for the companies mentioned in the report. y We submit that no material disciplinary action has been taken on KSBL by any Regulatory Authority impacting Equity Research Analyst activities. Karvy Stock Broking Limited Plot No.31, 6th Floor, Karvy Millennium Towers, Financial District, Nanakramguda, Hyderabad, 500 032, India Tel: 91-40-2331 2454; Fax: 91-40-2331 1968 For More updates & Stock Research, visit www.karvyonline.com 5