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Valuation factoring in industry-leading performance

Strong growth to continue, but attrition worrying

* PSYS reported a strong 1QFY22, with USD revenue growth of 9.2% QoQ (300bp above our estimate) and 17% EBITDA margin, despite seasonal visa costs and robust employee additions.

* The company’s capability in maintaining its over USD200m TCV run-rate is encouraging and should result in it continuing its industry-leading growth rate in FY22. With a strong demand commentary and deal momentum, we expect it to continue to deliver top tier IT Services revenue growth among our midcap IT coverage (over 18% FY20-23E CAGR).

* On top of this, the management guidance of good growth in the Alliance business should help it deliver 24.6% USD revenue growth in FY22, despite a higher base effect (12.9% YoY) in FY21.

* We continue to expect PSYS to deliver a 50bp improvement in EBITDA margin in FY22, helped by a favorable operating leverage, which should compensate for any pressure from a wage hike or growing attrition (16.6% in 1Q, up 490bp QoQ).

* After a 290% (v/s Nifty IT index up 77%) return in PSYS over the last one year, the stock is now trading at 29x FY23E P/E. This is one of the highest in our midcap IT Services peer group, and factors in a favorable growth and demand environment. Hence, we are downgrading the stock to Neutral (from Buy) as we see limited upside from current levels.

* We upgrade our FY22-23E EPS estimates by 6-7% on the back of a 1QFY22 earnings beat. We continue to value the stock at 30x FY23E EPS.

Exceptional topline performance

* In USD terms, revenue/adjusted EBIT/adjusted PAT grew 27%/69%/76% YoY (est. 24%/57%/55%) in 1QFY22.

* In USD terms, revenue grew 9.2% QoQ to USD166.8m, above our estimate of 6.1%.

* Growth was led by an 11.5% QoQ growth in Services, but was partially offset by a 4.1% decline in the IP business.

* Healthcare grew 15.9% QoQ, leading to a sequential growth for PSYS. BFS posted a strong performance (11.7% QoQ). Technology and Emerging Verticals grew 5.1% QoQ.

* EBIT margin, adjusted for a one-time expense, stood at 14.1% (+90bp QoQ and 60bp higher than our estimate). The one-time expense was on account of the impairment of an investment made in a startup.

8 Adjusted PAT stood at INR1.6b (+15.1% QoQ), a 13% beat on our estimate, led by higher operational and other income.

* Strong headcount additions were seen for the third straight quarter (+1,224 QoQ). Utilization increased by 100bp to 80.1%.

* Attrition inched up to 16.6% TTM (+490bp QoQ).

* In 1QFY22, TCV stood at USD244.8m, with 60% new TCV. ACV stood at USD188.8m, implying a decline of 5.9% QoQ.

* Growth was led by a 15.1% QoQ increase (above the company growth rate) in 2- 5 accounts.

* Total net cash stood at INR20b.

Highlights from the management commentary

* PSYS delivered yet another strong quarter, reporting a growth of 9.2% QoQ and 27.3% YoY. Growth was broad based across all verticals, led by Healthcare. All client buckets grew, depicting increased confidence in its account mining capabilities.

* Robust growth in the top account indicates good traction in the Alliance business. The management said this segment is seeing profitable growth.

* PSYS has resumed its normal wage cycle, which starts in July. The management expects a 250-275bp impact due to the same in 2QFY22. It said it has sufficient levers to offset this impact.

* The company sees significant tailwinds from revenue growth. This, along with utilization optimization and improvement in the lateral-fresher mix, should aid in margin expansion. The management intends to look into areas where there is pricing flexibility.

Valuation and view – improving growth profile already captured

* Historically, execution challenges and volatility in the IP portfolio have led to inconsistency in the company’s performance. However, we have noticed steady progress on the execution front after a change in the management/strategy.

* This is evident from the robust performance of the Services segment over the past few quarters, notwithstanding the COVID-19 disruption.

* We expect a higher emphasis on annuity revenue to address the performance consistency issue to some extent.

* The company’s robust performance in FY21, a healthy order book, and a strong deal pipeline indicates an encouraging near-term outlook. Its guidance to defend margin is a key positive.

* The stock is currently trading at 29x FY23E EPS. Our TP is based on 30x FY23E EPS. We downgrade the stock to Neutral as we believe the positives have already been captured.

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