Dire client issues to be resolved by Q4; valuations very attractive; ‘Buy’ retained.
We reiterate BUY rating on Hexaware as we expect the worst of client-specific issues to be behind by Q4CY19 with revenue growth likely to sustain in double digits on an organic basis in CY20. Stock sentiment has been impacted on account of
(i) high exposure to BFS vertical (38.6% of revenues) where the company has a higher exposure to capital market and secondary mortgage sub-segments, which are going through segment and client specific issues respectively, and
(ii) potential for supply overhang as the promoter entity looks to potentially lighten up on the name (and eventually exit) over the next few years.
We expect momentum to improve in the BFS vertical in CY20 as spends at the large secondary mortgage client seeing issues should bottom out in Q4CY19. Though supply overhang remains an issue, on fundamentals, we see valuation as very attractive at 13x CY20e EPS for 12.2% EPS CAGR over CY19-21.
Revenue and margin expectations for Q4CY19: We expect USD revenue growth to be 2.3% q-o-q in Q4CY19 which translates into growth of 17.2% for CY19 (vs guide of 17-18%). Client specific rampdown is expected to put growth back by >2% q-o-q in Q4CY19, which implies strong underlying momentum across other clients. We expect Ebitda margin in Q4CY19 to decline by 40bps q-o-q to 15.6%.
Maintain Buy: We see risk-reward as very attractive given (i) bargain basement valuation of 13x CY20e EPS for 12.2% EPS CAGR over CY19-21; (ii) worst of client specific issues likely being behind by Q4CY19; (iii) sustained spend momentum in verticals like Healthcare & Insurance, Professional Services and Travel & Transportation; (iv) likelihood of better NN deal momentum in Q4CY19; and (v) stronger EN pipeline around the themes of cloud native and customer experience transformation.