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FSOL’s Q4FY23 operating performance was a tad better than our expectations. Revenue growth was led by collection seasonality and traction in utility and CMT (extop client). Mortgage revenue declined to USD17mn in Q4, down ~USD2mn QoQ. Management believes the worst is behind in mortgage and expects some stability to return, anticipating moderate growth in H2FY24. FSOL has guided for 2-5% CC revenue growth in FY24, factoring in the weak start, 3% headwind from mortgage and another 3% impact from the anticipated offshore shift in key accounts. Guidance assumes a 1.0-2.5% QoQ decline in Q1 and recovery from Q2 because of traction in CMT (ex-top client) and UK BFS, and recovery in collections and healthcare. Management has guided for 11-12% EBITM in FY24, factoring in planned growth investments, lower benefits from Ind-AS 37 and prevailing macro uncertainties. We have cut our EPS estimates by <1% for FY24E/25E, factoring in steady Q4 and conservative FY24 guidance. We expect the stock to gradually recover as investors gain confidence on a sustainable recovery in sequential revenue growth and margin. We maintain our BUY rating with an unchanged TP of Rs130 on 13x Mar-25E EPS.

Result summary: For Q4FY23, FSOL’s revenue grew by 3.8% QoQ to USD190mn (2.5% CC), a tad above our estimate of USD188mn. In FY23, revenue excluding mortgage and acquisitions grew by 13.7% CC YoY. EBITM expanded by 220bps QoQ to 11.6% in Q4, 20bps above our expectations. Net profit stood at Rs1.41bn, beating our estimates due to higher other income (includes ~Rs65mn on account of changes in the fair value of the liabilities for the purchase of NCI). Mortgage revenue declined to ~USD17mn in Q4 vs. ~USD19mn in Q3, with contribution from origination:servicing at a 1/3:2/3 ratio. Healthcare remained flat sequentially due to the conclusion of project-based engagements, delay in deal ramp-ups and deal closures in HPHS, and continued softness in provider. Despite the continued decline in mortgage, BFS remains stable on account of traction in UK BFS and collection seasonality. Diversified industries reported strong growth in Q4 because of wallet share gain in a large utility client and new client addition. What we liked: Stability in performance, traction in CMT (ex-Sky) and diversified industries, and healthy cash conversion (OCF/EBITDA >100% in Q4). What we did not like: Softness in healthcare and weak Q1FY24 guidance.

Earnings call KTAs: 1) FSOL has defined its long-term strategy to manage the external variabilities and ensure a more balanced business mix. The company’s focus remains to: a) diversify within the BFS and CMT verticals to reduce cyclicality, b) drive growth by building adjacent capabilities, adding new clients and growing existing clients, and c) leverage digital tools and services to drive automation. 2) Management expects Q1 to be soft due to seasonality from collections and HPHS, ramp down of project-based work in healthcare, and ending of the implementation phase of a large BPaaS deal. 3) US PHE is expected to end by May 11, 2023, resulting in 5-14mn people losing their medical coverage, which is likely to drive growth recovery in provider in H2FY24. 4) UK BFS continues to deliver a strong performance, which helped in diversifying the broader BFS segment and lowering mortgage concentration. Management expects the momentum to continue in FY24, with a focus on new client additions and more offshore activity. 5) The company is looking to diversify its collection business as a multi-offering with penetration into FinTech, auto, telecom, and e-financing, expand geographically, and drive revenue and margin growth in the legal collection segment. 6) ETR for FY23 was ~16.5%. It is expected to be 18-20% for FY24, on account of UK tax rate moving from 19% to 25%. 7) US credit card delinquency inched up to 2.25% in Q4 vs. 2.09% in Q3 and is expected to rise further. Consumer credit metrics continue to soften, which augurs well for the collections business. 8) Top client concentration in CMT reduced to 70% in Q4 vs. 80% YoY. CMT (ex-top client) grew by 44% YoY, led by growth in US communications, Edtech, Digital Media and tech clients.

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