Quick Heal: Risk reward evenly balanced, says Jefferies

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Published: September 10, 2016 6:01:24 AM

Expect revenue/EPS CAGR of 16%/18.5 % in FY16-19e, driven by growth in enterprise and government and mobile segments, even as headwinds remain

Expect revenue/EPS CAGR of 16%/18.5 % in FY16-19e, driven by growth in enterprise and government and mobile segments, even as headwinds remainExpect revenue/EPS CAGR of 16%/18.5 % in FY16-19e, driven by growth in enterprise and government and mobile segments, even as headwinds remain

Quick Heal’s dominant market share is backed by strong distribution and investments in products although the latter has impacted profitability. This is balanced by the risks of incremental competition, technology changes, device transitions and e-commerce proliferation. While past profitability has been lacklustre, the fixed cost nature of the business should imply margin leverage ahead. We forecast revenue/EPS CAGR of 16%/18.5% in FY16-19e. Initiate with hold.

Leading security software provider

Quick Heal has a 30% market share in the retail antivirus market, its key differentiator being the scale of distribution network (20K partners across 36 cities). 98% of business is driven by PCs implying it is highly leveraged to the PC cycle. Small Medium Businesses (SMBs) is a new focus area with increasing spending and lower penetration. The adoption of antivirus products in mobile phones remains uncertain for now with future technology transitions being even more ambiguous.

Strong macro story has offsetting risks

Tailwinds are low PC penetration and an even lower adoption of antivirus amid rising virus attacks and costs per attack. At the same time, large global competitors, a rapid transition from PCs towards mobile devices, bundling of security software by operating system vendors, adoption of security products on freeware model and e-commerce growth are key risks.

Investments have hit profitability

The company’s investment in hiring and brand building has resulted in 23ppt margin compression in FY12-16 (personnel cost was 14ppt impact). While the bulk of investments are now behind it and margin leverage could kick in, headwinds would remain in the form of steady investments in advertising/channels, and increasing tech intensity mandating investments in people and equipment. This should limit the margin recovery for the company.

Valuation/Risks

We forecast a 16%/18.5% CAGR in FY16-19e revenue/EPS and 60bps margin expansion. Our 12M PT of R260 is based on DCF and implies a 24x/20x multiple on FY17e/18e EPS forecasts. While there is a case for operating leverage in the business, it has not played out in the recent past, capping our margin expansion forecasts. Initiate at hold.

Risks: (+) stronger PC cycle, execution on enterprise business, global virus threat; (-) slowdown in PC growth, security product bundling with operating system, higher competition, less adoption on mobile, higher use of freeware, e-commerce proliferation.

Leading security software provider with unique distribution model

Quick Heal is a provider of security software products and solutions in India with a market share of over 30% in the retail segment, according to an Industry Report by Zinnov. A key differentiator of the business is the scale of distribution network (20,000 channel partners) across 36 cities. Almost all of Quick Heal’s business is driven by PCs (98% in FY16) which makes it highly leveraged to the PC cycle. While the company is progressing towards mobiles, adoption rates of security products in such devices remains low and future technology transitions are ambiguous. Quick Heal has increased its active licences by 2x (to 7.3mn) between FY12 and FY16.

Risk reward remains balanced, initiate with Hold

We forecast revenue CAGR of 16% in FY16-19e driven mostly by growth in enterprise and government and the mobile segments, with retail business likely to show 12-15% y-o-y growth (a slight premium to the PC shipment growth of 10%). We are also building in a margin expansion of 60bps in FY16-19e. While there is a case for operating leverage in the business, it has not played out in the recent past, capping our margin expansion forecasts. FY16 and 1Q17 results have failed to inspire confidence, in this regard. Our 12 month price target of R260 is based on DCF valuation and implies a 24x/20x multiple on FY17e/18e earnings forecasts. We believe that this is also justified by the 17% Ebitda CAGR that we project for the company over

FY16-19e. Initiate at hold.

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