>HEXAWARE TECHNOLOGIES LIMITED: Improvement in utilization level, moderation in attrition and higher contribution of offshore revenue

We initiate coverage of Hexaware Technologies with a LONG rating and March’13 price target of Rs 143, based on 12x March’13e TTM earnings which implies an upside of 20% from current level. In 2008-09 Hexaware’s revenue was hit severely given the disproportionate exposure to discretionary spend segment. Since then the company undertook realignment of its business segment resulting in industry leading growth (CQGR of 8.1%) for the last 8 quarters and also significant improvement in operating performance (wherein operating margin improved by ~1600 bps) during the same time frame. Given the recent deal wins, we expect that the company to sustain its revenue growth momentum going ahead and believe that the company has enough levers to at-least maintain its Q4CY11’s operating margin if not improve
the same.


■ Recent large deal wins provide better visibility over revenue – expect $ revenue CAGR of 20% from CY11-14E: Recent deal wins amounting to TCV of ~$600 mn by Hexaware which are long term in nature (as compared to short-term earlier), spanning across various service lines provides better visibility and much-needed stability to the future revenues. As most of the deals are with existing clients, it will help Hexaware improve its offshore mix and employee pyramid metrics. We expect Hexaware to clock a $ revenue CAGR of 20% from CY11-14E.


■ Still enough levers left to aid margin improvement – company’s target of EBITDAM of 25% a realistic target: Aided by sharp rupee depreciation (~11% in Q4CY11), Hexaware clocked an EBITDA margin of 23% (lifetime high) in the Q4CY11. The company intends to achieve 25% EBITDA margin in next couple of years. We think that an EBITDA margin of 25% is definitely a realistic target and the company still has enough levers to achieve the same. Some of the potential levers are (a) Change in employee mix – Hiring more of freshers (b) Reduction in SG&A expense (c) Improvement in utilization level, moderation in attrition and higher contribution of offshore revenue.


■ Revenue growth momentum and operational stability is here to sustain; Strong dividend policy to support our TP: Post 2008-09 business restructuring, the company has reported industry leading growth and significant improvement in operating performance. We believe this change is sustainable owing to recent deal wins, and operational stability. Hexaware has a high dividend payout ratio of ~50% along with dividend yield of 3.5% which limits the downside risk to our price target (as evident from the DDM fair value of Rs 116). The stock has kept pace with business performance (has doubled over the last 12 months) but we still see upside from current level because of continued revenue growth momentum, healthy dividend pay-out policy and improving operating performance.


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