Growth outlook continues to improve across segments
Margin to normalize going forward
* QUESS’ revenue growth (flat QoQ/+24% YoY) in 1QFY22 was in line with our estimate. However, EBITDA margin dipped by 80bp QoQ due to a combination of one-off factors (losses in Monster.com and pass through of revenue) and seasonal impact of higher SG&A expenses on account of a wage hike.
* Adjusted PAT was further impacted by higher ETR (impact of INR160m) due to dividend distribution by its subsidiary in Manila. Adjusted PAT stood at INR306m in 1QFY22, below our estimate of INR 538m.
* We continue to see QUESS as a key beneficiary of a return to normal operations across industries, especially in its Workforce Management and Operating Asset Management verticals (83% of revenue). With the addition of new clients and pick up in associate headcount, we expect QUESS to deliver strong operational performance from 2QFY22, despite partial impact of the lockdown. It should also continue to benefit from strong demand for IT Staffing and deliver 26% revenue growth in FY22E after a flat FY21, partially aided by a low base.
* We expect EBITDA margin to meaningfully improve from 2QFY22 onwards, due to better operating leverage and the absence of one-off costs. Lower depreciation expenses should result in a 60bp YoY increase in FY22E EBIT margin to 3.8%. With a full impact of business normalization in FY23E, QUESS should deliver over 6% EBITDA margin, leading to 79% PAT CAGR over FY21-23E.
* QUESS should return to net cash status in the next 2-3 quarters, as no additional payout is required after the payout for acquisition of additional stake in the Conneqt business and dividend outgo in 1QFY22.
* Over the medium term, we expect QUESS to be a big beneficiary of the recent labor law reforms. Our TP of INR1,000 per share implies a multiple of 21x FY23E EPS. We reiterate our Buy rating.
In line revenue; big miss on profitability
* Revenue grew 24% YoY to INR29.9b (in line), EBITDA rose 2% to INR1.3b (est. +16%), and reported PAT increased by 22% to INR446m (est. +48%).
* Revenue was flat sequentially (-0.6% QoQ). While Workforce Management and Operating Asset Management remained flat, GTS (including emerging businesses) declined by 2% QoQ.
* Adjusted EBITDA margin stood at 4.4%, down 60bp QoQ and 100bp YoY (est. 5%). This excludes a net provision write-back of INR140m (INR1.2b provision made in 4QFY21).
* Dip in margin was majorly led by an increase in SG&A expenses on account of a wage hike, and losses in the Catering business and Monster.com.
* Adjusted PAT dipped by 73% QoQ to INR306m (est. INR538m). This was led by lower operating income and higher tax (INR160m) on account of the payment of dividend by its subsidiary in Manila.
* General Staffing revenue grew 26% YoY, with 48 new customers added.
* Headcount is up 15% YoY and 1% QoQ. Core-to-associate ratio stands at a historical high of 350.
* IFM revenue increased by 5% YoY, with 53 client wins v/s 26 in 4QFY21.
* Terrier Security revenue fell 3% on a QoQ basis.
* Revenue in the Industrial business rose 32% YoY, with 11 new clients won in 1QFY22.
* OCF/EBITDA stood at 66% as compared to 93% in 4QFY21.
* Net debt stood at INR1.5b in 1QFY22 from a net cash position of INR990m in 4QFY21.
* DSO increased to 57 days in 1QFY22 from 54 days in 4QFY21.
Key highlights from the management commentary
* Headcount in General Staffing grew 15% YoY, and QUESS added 48 new customers in 1QFY22.
* The management continues to see technology adoption across the industry, leading to a healthy and robust demand pipeline. However, fear of a third COVID wave has made clients cautious, leading to deferment in hiring.
* The Training and Skill Development business witnessed a few shutdowns, but the management will continue with its B2G business.
* Monster.com witnessed a 69% YoY growth as product performance continues to improve. The management said the retention rate and spending by key customers is improving.
Valuation and view – company-level improvements to drive re-rating
* Given some amount of uncertainty in the economy (due to back-and-forth lockdowns), some of the otherwise permanent roles are likely to be filled through flexi-staffing as employers attempt to keep cost variable. We noticed similar trends in the immediate aftermath of the GFC/demonetization, when staffing companies benefitted from positive hiring trends in certain verticals. Such a trend would likely play out in the near term, benefitting business services firms such as QUESS.
* Over the medium term, as both the Center and state governments look to liberalize and formalize the labor markets, QUESS should be among the biggest direct beneficiaries.
* We welcome the corrective steps taken by the new management to address some of the investor concerns. The improvement in cash conversion/RoE should drive a re-rating. Our TP implies 21x FY23E EPS.
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