Margins expected to fall in CY20e; downgraded to ‘Add’ with reduced TP of Rs 330
Hexaware reported a subdued Q1CY20 with revenues declining by 1.1% q-o-q in CC terms and like to like Ebitda margin (excluding IndAS-116 benefit in Q1CY20) declining by 150bps q-o-q. Covid-19 impaired revenues by 2-3% in Q1CY20 with the impact likely to be higher in Q2CY20 though better calendar should be a moderate offset. Impact of Covid-19 on Ebitda margins was 100-120bps in Q1CY20 with there to be further drags in Q2/Q3 CY20 in our opinion as utilisation gets incrementally impacted and some pricing concessions flow through.
Hexaware’s margins adjusted for Covid-19 and IndAS-116 will decline in CY20 in our opinion, which would mark the 7th consecutive year of decline in margins. Management believes that the impact of Covid-19 will likely be lower than for their peers especially given exceptionally positive feedback received from customers. However, we would be watchful of the near-term business impact in stressed verticals like Travel & Hospitality and eventual second order impact in segments like asset management.
Retain positive stance but downgrade to ADD: Contrary to perception, customer experience transformation including Mobiquity, which is perceived to be a discretionary spend area actually did well in the quarter which the management expects to continue as a trend. Likewise, management expects demand in the BFS and Hi-Tech & Professional Services segments to remain relatively resilient in Q2CY20 as well.
IMS growth should also gradually recover. Company did not announce any dividend in the quarter and we see less scope of a payout even in Q2. Valuation of 14x CY21e EPS is reasonable but we downgrade to Add as we reset target multiples across our coverage. Our TP is revised to Rs 330 (prior Rs 430) based on 15x Mar’22e EPS (earlier 16x Mar’22e EPS).