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Strong operating performance; margin outlook ahead of expectations

PSYS reported better-than-expected operating performance in Q3. Revenue grew 3.4% QoQ, despite impact of the higher-than-usual furloughs (150bps), lesser working days (50-100bps) and weakness in select clients. Management expects furloughs to extend into the next quarter and impact revenue growth by 50-75bps in Q4. Revenue growth was broad-based across Software, Hi-tech & Emerging industries (4.1% QoQ; ex-top client: 7.7%), Healthcare & Lifesciences (2.9%), and BFSI (2.8%). The services business has posted 9.2% CQGR in the last eight quarters, and Management remains confident (albeit watchful of macro uncertainties) about sustaining the growth momentum on the back of continued demand, robust deal intake (USD440mn in Q3; 1.7x book-to-bill), healthy deal pipeline, new logo additions, and steady progress in client mining. Management expects EBITM to expand by 200-300bps over the next 2-3 years, ahead of our expectations, on the back of revenue growth, flattening pyramid, SG&A leverage with progress on client mining, and large deals traction. We raise our EPS by 1%-8% for FY23E-25E, factoring-in the Q3 performance and higher margin assumptions. We retain BUY with TP of Rs4,500/share at 25x Dec-24E EPS (earlier Rs4,125).

Result summary: Revenue grew 3.4% QoQ to USD264.4mn (3.5% CC QoQ), above our expectations of 3% CC QoQ, driven by steady growth in the Services business and continued momentum in IP. Services revenue grew by 3% QoQ, aided by 4.9% growth in volume, while blended realization declined by 1.8%. EBITM expanded by 80bps QoQ, on account of higher lateral utilization, flattening employee pyramid, revenue growth, IP-led revenue growth, and currency movement (+60bps). Reported net profit grew 8% QoQ to Rs2.4bn. Adjusted for the exceptional item pertaining to provision for forego of export incentives (~Rs296mn), net profit stood at Rs2.7bn. The top client declined ~12% QoQ on account of planned ramp down, which started last quarter. Management believes that top-client revenue has bottomed out and expects a sharp reversal in a few quarters. Revenue from the top-50 (ex-Top 2) clients grew 7.7% QoQ. PSYS has seen steady improvement across client buckets. Order booking was at a record high, at USD440mn (1.7x book-to-bill) of TCV, including USD239mn of new business TCV. What we liked: Broad-based revenue growth momentum; revenue & margin beat; record-high order book; moderation in attrition (21.6% vs 23.7% QoQ). What we did not like: Increase in DSO to 67 days (7 days QoQ), weakness in top client (fell ~12% QoQ).

Earnings-call KTAs: 1) Revenue growth momentum moderated in North America (1.5% QoQ) due to weakness in the top-2 clients and higher than usual furloughs. 2) Growth in Europe (12.2% QoQ) was on the back of deal wins, although Management remains watchful of the macro conditions. 3) Company aspires to outgrow the industry, irrespective of the macro outcomes. 4) LTM attrition for the quarter stood at 21.6% vs 23.7% in Q2, and Management expects it to continue trailing downward. 5) The company has hedges of USD214mn as of end-Q3, at an average exchange rate of Rs81.55/USD. 6) Company declared an interim dividend of Rs28 per share. 7) The billing rate was impacted due to higher furloughs and lower number of working days. 8) DSO for the quarter stood at 67 days and was impacted by the spillover of collections (2.5-day impact), deferred credit given to some clients in the IP business (3.5 days), and clients with a December year-end seeing some shift from unbilled DSO to billed DSO. Mgmt expects billed DSO to stabilize at ~65 days. 9) Company added over 3,000 freshers in H1FY23 and has made an offer to 1,200 freshers, who are expected to join in the next few quarters. 10) Utilization (ex-fresher) improved 340bps QoQ to 83.3%.

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