* Soft quarter; misses estimates: Firstsource Solutions (FSL) has reported yet another lackluster earnings performance, owing to macro-economic headwinds and execution challenges. Despite Q4 being a strong seasonal quarter for the company, Q4FY2017 revenue grew by 1.4% QoQ on CC basis, which was broadly in line with our muted estimates. The revenue growth was impacted due to currency headwinds and significant contraction in the Mortgage Business (40% decline compared to Q1FY2017) in view of the hardening of US bond yields (reflected in revenue loss of ~$5 million in ISGN). The Operating Profit Margin (OPM) declined by 101BPS QoQ to 11.1% (below estimates) owing to restructuring cost in the Mortgage Business (loss of Rs15 crore in Q4FY2017). Depreciation charge was down 29% QoQ to Rs11 crore on account of change in the accounting policy under the IND AS fair policy accounting treatment. Net profit for the quarter fell by 6.6% QoQ to Rs65.4 crore.
* Business headwinds continue unabated:
(1) The FSL management remained cautious on the demand trajectory for FY2018 due to a sharp deterioration in its Mortgage Business, and softness in the Collection Business. However, the management does expect the Healthcare Business to see an improved traction going ahead, along with the Customer Management vertical amid an increase in deal size. Overall, FSL foresees industry level growth of 6-8% in CC terms in FY2018; (2) The management expects a muted Q1FY2018 on account of seasonal weakness and headwinds in the Mortgage Business. It also expects OPM to fall on account of an increase in the Employee Cost (1200 headcounts from Sky deal in March 2017). For FY2018, the FSL management expects OPM to improve by 50-60BPS on CC basis; (3) Overall, the deals pipeline has improved to $375 million from $355 million in Q3FY2017; (4) ISGN will continue to witness challenges in FY2018 too due to headwinds in the Mortgages Business (FY2017 revenue of $43 million and EBIT of $2 million). The management expects some improvement in ISGN by the end of Q2FY2018; (5) The management expects the Sky deal to contribute $28-30 million to FY2018 revenue on account of restructuring (down from the earlier expectation of $35 million).
* Maintain Hold owing to macro overhang with unchanged PT of Rs43:
We have tweaked our earnings estimates for FY2018E due to the weak operating performance in Q4FY2017. We have also introduced FY2019 estimates in this note. We do not see any material improvement in the company’s earnings trajectory over FY2017-FY2019E, owing to lack of clarity on the revival of the Mortgage Business volume, Brexit and currency depreciation (especially GBP, the UK contributes 37.6% to FSL’s total revenue). We believe that the ongoing macro-economic overhang will restrict the stock outperformance in the near-to-medium term. However, any favorable corporate event to unlock the value for minority shareholders would be an upside trigger. Given the uninspiring outlook on profitability for the coming quarters and the macro headwinds, we maintain our ‘Hold’ rating with an unchanged price target of Rs43.
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