Strength in organic business intact
Acquisitions continue weighing on profitability
* Encouraging organic growth:
QUESS’ revenue grew 50% YoY to INR21b (inline) in 2QFY19. Organic growth of 26% YoY was encouraging, boosted by continued traction in People & Services business (+34% YoY) and robust growth in Integrated Facility Management (+26% YoY).
* Profitability still subdued:
EBITDA margin contracted 30bp YoY to 5.4%. Margins shrank in all segments, either because of investments, restructuring or acquisitions. Despite strong revenue growth, PBT grew by a mere 5% YoY to INR690m due to (i) lower operating margins (-30bp YoY), (ii) depreciation (+100% YoY) and (iii) interest expenses (+80% YoY). Acquisitions continue weighing on profitability. Consequently, we revise our margins estimate downward, resulting in an 8% cut in earnings.
* Improving on problem areas:
The direction of several initiatives was encouraging in QUESS, the fructification of which would result in a positive shade on performance and viewpoint. These include: (i) efforts to expand the EBITDA margin to 6% by end-FY19 and to 8% in a few years, (ii) aim to convert 30-40% of EBITDA to operating cash, (iii) merger of subsidiaries into the parent, and (iv) a more selective approach on acquisitions with the intent of not adding additional verticals.
* Valuation view:
We had downgraded QUESS when the impact of aggressive inorganic foray started to adversely impact the financial performance. However, we are encouraged by the steps the company is taking for margins improvement, cash conversion and focused acquisitions. We reckon progress on the same would start to reflect in the form of improved performance and valuations. While we remain encouraged by the long-term prospects of QUESS, we will reconsider our stance once we see start seeing an improvement on the above parameters. Maintain Neutral.
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