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Watchful on margin trajectory
Hexaware’s 1QCY19 results were broadly inline with our estimates. Hexaware has maintained its guidance of 12-14% organic revenue growth in CY19E, with EBITDA growth likely to be similar to revenue growth despite a fairly high askrate of 4% CQGR in USD terms over 1Q-4QCY19. Management expects margin performance to improve in coming quarters due to better pricing & utilization however we believe margin guidance (7.5% CQGR) looks stretched owing to lack of tailwinds. Gross margin was lowest in last 6 years (30.5%), management mentioned rising proportion of onsite revenues led to the fall however we believe rising competitive intensity & onsite investments may have attributed to the fall. We believe key negative for Hexaware is softness in BFS (41% of revenue) mainly focused in capital markets & buy side for new deals which have longer sales cycles. We remain watchful on expanded attrition levels of 18% (6 year high) along with supply side constraints. We expect revenue & EPS CAGR growth of 12.2% & 9.7% over CY18-CY20E & value Hexaware at 14x Mar-21 to arrive at an unchanged target price of Rs. 325. Hexaware currently trades at 15.7x & 14.3x CY19E/CY20E EPS. Maintain Reduce.
* Inline revenue performance:
Hexaware reported an inline revenue performance in 1QCY19 at US$ 180mn (Ple:180.5mn) growth of 2.2% QoQ in USD terms. CC revenue clocked at 2% QoQ. Growth components were volume growth (+1.2% QoQ), cross currency movement (+0.3% QoQ), higher billing days (+0.7% QoQ).
* Cautious on margin trajectory:
EBITDA margins (excluding ESOP’s) fell by 73bps QoQ, inline with our estimates of 15.2% due to impact from forex, visa cost and other costs, which was partial offset by SG&A leverage. Q1CY19 saw gross margin decline by 180 bps QoQ to 30.5% which was partly offset operating leverage in SG&A (down 145 bps QoQ), thus providing cushion to the impact on EBITDA margin. Gross margin was lowest in last 6 years, management mentioned rising proportion of onsite revenues led to fall. Management expects margin performance to improve in coming quarters due to better pricing & utilization, we believe margin guidance (7.5% CQGR) looks stretched owing to lack of tailwinds.
* Weak growth in largest vertical (banking) keeps us cautious:
Hexaware reported 1% QoQ decline in BFS. From vertical perspective, growth was led by Professional Services (+5.5% QoQ) and MFG & Consumer (+15.6% QoQ). Travel & Transportation (-1.6% QoQ) continues to be under pressure. Geographically, revenue from Asia Pacific region grew by a strong 12.9% QoQ, US revenue grew by 1.1% QoQ while Europe declined by -0.9% QoQ.
* Comments on Baring acquisition of NIIT Tech:
Management mentioned that both the deals are from different funds (Hexaware invested fund to expire in 21-22) & as per the contract there cannot be possible merger between 2 entities. We don’t see any major change in revenue momentum or deal wins or any disruption in management teams. We believe both entities will run separately.
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