Profitability miss traced down to acquired entities
An elevation of risks may cap upside
* Encouraging trends in organic business:
Quess Corp’s 52% YoY revenue growth to INR19.7b was a 4% miss to our estimates. While growth in the organic business remained strong (40% YoY growth in People & Services), a marginal slowdown was seen in Integrated Facility Management (22% YoY in 1QFY19 v/s 28% in 4QFY18). We reckon Quess organically grew 29% YoY.
* Material PAT miss:
EBITDA margin of 5.2% shrank 60bp on both QoQ and YoY basis. The company attributed the contraction to (i) seasonality in Conneqt and Manipal and (ii) investments in Monster and DigiCare. Benefits from these investments are expected to be seen in 2HFY19. PAT at INR544m grew by 41% YoY, against our estimate of +123%. While half the miss on PAT was because of operating profitability, the rest was driven by charges on the non-controlling-interest put option, lower other income, and higher ETR.
* Acquired entities weigh upon performance:
Together, the operating miss and non-cash items have a material bearing on our earnings estimates (-20/- 13% for FY19/20). All the reasons that the miss were ascribed to can be traced down to acquisitions. The surprise on seasonal weakness could be a function of a lack of foresight given the recency of acquisitions; however, the outcome of these investments would only be unfolded by time and reflective in the financial performance.
* Valuation view:
Our thesis on Quess was based upon the long-term prospects of the company, given the high-growth opportunities, aggression shown on expansion and flawless execution. However, recent acquisitions have been larger in size, of debatable health and perhaps unrelated. They may reduce the potential of seamless integration, and negatively influence the financial performance in the near term, capping upside from a one-year perspective. The stock has appreciated by 35% since we initiated coverage on it nine months ago, and we deem the current risk profile to be relatively elevated. We, thus, downgrade our rating to Neutral.
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