Execution intact valuation unwarranted
* Hexaware went up by over 20% in yesterday’s trade (closed 8% high) without any filling or announcement. The likely factor in our opinion could be possible expectations of upward revision in guidance and strong Q2CY18 numbers. However, we do not see these valuations sustainable and should cool off in the subsequent sessions.
* Despite strong Q1CY18 and strong visibility of demand, the management refrained from revisiting its guidance upwards (guided for 10-12% growth in CY18) given the lower visibility on client spends.
* Operating margins declined by 20bps qoq largely on the back of increased investments in S&M. The company has invested in: senior leadership, more feet on the ground, localization of sales in continental Europe and capabilities on Customer Experience segment.
* Hexaware has been quite consistent on growth performance and OPM discipline, however, sustained high valuations (25x on Mar’20) and low differentiated capabilities pose as key deterrent. Maintain SELL rating with a TP of Rs380 (valued at 18x Mar’20E)
Growth getting broad based; commentary remains confident
Hexaware has been consistent performer and has delivered strong 10%+ revenue CAGR over last five years. The growth has been skewed to few service lines (IMS, BPO, BI) whereas some of its segment continues to struggle given pertinent pricing pressure in these service offerings. Hexaware now plans to grow the troubled segments (EAS, PS) with a focused approach which is healthy sign. The management is confident about the emerging opportunities in the market and has therefore invested profits back into the business to boost its S&M (localization in Europe, senior hirings, more feet on ground etc). The company also believes that the Barings portfolio represents a strong potential business opportunity going forward, which will add another vector to growth. However, despite the strong growth and constructive commentary, the management has refrained from revising up its guidance for CY18. It expects strong Q2CY18 given the seasonality factor and may review the annual guidance only post Q2CY18 earnings given the continued caution in client spends. Profitability in Q1CY18 was impacted by accelerated investments in S&M. However, the management expects full year CY18 EPS to grow in line with revenue growth range of 10-12%.
Low differentiation to restrict growth acceleration; Maintain SELL
Hexaware has been a consistent growth performer however, given its low differentiation on our three vectors of growth and its ‘Automation First’ culture that would mean sustained pressure on pricing realisations would restrict further growth acceleration. We expect a robust 11%/13% CAGR over CY17-20e for Hexaware. However, despite these high growth expectancy we see the current valuations are unwarranted and thus maintain our SELL rating on the stock with TP of Rs 380 (valued at 18x Mar’20e earnings).
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