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Uninspiring revenue performance

Birlasoft reported a mixed operating performance in Q2FY23. Revenue missed our expectations, while margin came in above our estimates. Management suggested that Q2 performance was weaker than its expectations due to delays in deal ramp-up, furloughs at certain clients, and postponement in expected work extension after the completion of a large project. The company continues to grapple with weakness in life sciences and E&U, which declined by 7.4% and 1.3% QoQ, respectively. The company is witnessing a trend of elongated deal closure and execution cycle, as clients look to reduce their immediate cash outflows; however, it has not witnessed any project cancelations. Despite potential furloughs in Q3 and prevailing macro uncertainties, management remains confident of delivering double-digit revenue growth in FY23, considering improving supply-side situations, strength in BFSI and manufacturing, and healthy deal wins. We have cut our EPS estimates by 1.9-3.3% for FY23E-25E, factoring in Q2 performance. Revenue growth acceleration remains key for stock price performance in our view. We retain our Buy rating with a TP of Rs370 at 16x Sep-24E EPS (Rs380 earlier).

Result summary: Birlasoft’s revenue grew by 0.1% QoQ/8.7% YoY to USD148.8mn (CC 1.1% QoQ/11% YoY), below our expectation of USD152.6mn. EBITM expanded by 10bps QoQ to 13.1%, 50bps above our expectations. EBITM expansion was driven by lower cost of service delivery, lower travel costs, offshore shift, and operating efficiencies, which negated the impact of salary hike (-210bps). Net profit declined by 4.7% QoQ to Rs1.15bn, below our expectations of Rs1.18bn, primarily on account of lower other income. Revenue growth was led by the BFSI and manufacturing verticals, which registered sequential growth of 7.4% and 1.2%, respectively. Among services, Cloud and Base services and Business and Technology Transformation led the growth, registering 6.3% QoQ and 3.5% QoQ growth, respectively, while Enterprise Solutions declined by 6.1%. Larger accounts continue to drive growth with the top5, top-10, and top-20 customers registering 1.4%, 0.6%, and 1.1% QoQ growth, respectively, in line with the company’s strategy to focus on strategic accounts and expand relationships. The deal intake in Q2 stood at USD166mn, including net new TCV of USD138mn. What we liked: Margin trajectory, strong growth in BFSI, healthy deal intake, and cash conversion. What we did not like: Muted revenue growth, continued weakness in E&U and lifesciences, and elevated attrition.

Earnings call KTAs: 1) Management indicated that life sciences revenue growth was impacted by furloughs in Q2. Excluding this, revenue growth would have been flat sequentially. 2) Q3 is a shorter quarter and is vulnerable to the impact of furloughs; while the company currently does not have any open furlough requests, it continues to engage in client conversations and remains watchful of the environment. 3) Sub-contracting costs remained flat sequentially but started trailing downwards towards the end of Q2, benefits from easing out of subcontracting costs are expected to flow in from Q3. 4) Support staff salary hikes are due in Q3, which are expected to have an adverse impact of ~100bps on margins. 5) It expects a flat sequential margin in Q3, considering furloughs and salary hikes for support staff. Q4 margin is expected to be better as full benefits from revenue growth acceleration, easing supply pressure, offshore shift, weak rupee, and operational efficiencies will accrue. 6) Attrition stood at 27.4% for Q2 and is expected to start trending downwards further from Q3. 7) The company made net additions of 193 in Q2. It hired 253 freshers in Q2 and expects to hire ~500 more in H2FY23. 8) ETR for Q2 stood at 21.8% on account of tax refunds in the US for prior periods; normalized ETR is expected to be at 25-26%. 9) The company declared an interim dividend of Rs1.5/share.

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