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Buy Quess Corp Ltd For Target Rs.637 - HDFC Securities

Our Take:

Quess Corp is the no.1 player in temporary staffing space and 4 th largest staffing company globally. It also offers facility management and industrial asset management services to diverse end users. Quess had a team of ~384,000 employees across India, North America, South America and South-East Asia across all segments and serves over 2600+ clients worldwide as on Mar-2020. As on Sep-2020, the total headcount registered steep decline and stood at 3,25,000 due to Covid-19.

We like Quess Corp due to 1) strong growth potential from all of its verticals 2) series of acquisitions in the last 2-3 years across all verticals 3) Focus on margin accretive growth and also on free cash generation. Management has reiterated at a target of ~20% RoE and ~20% YoY OCF (Operating Cashflow) growth over the next 3 years. They have also indicated that goodwill impairment may not be required any further. Management indicated that impact on operations in Apr-May’20 was not as bad as initially feared. Having large enterprises as customers and limited exposure to SMEs has helped the company in navigating through this crisis.

In general staffing, Quess remains focused on volume growth through new client additions. Renewed sales engine, focus on new acquisitions (enterprise, tech, SE Asia), rebuilding/modernizing talent, reinforcing performance culture and digital marketing are the key priorities in Monster. Faster collections, project closures and reducing capex intensity will be the key objectives in training and development. New management team is making encouraging efforts to address investor concerns around areas like governance, capital allocation, etc. We see the balance sheet rationalization, progress on exit from unrelated businesses (e.g. East Bengal Club) and the resultant improvement in return ratios as key positives. We think that past concerns like related party loans, Trimax project receivables, higher working capital cycle, Monster acquisition (EBITDA loss) and recent Covid-19 impact are almost priced in the stock. Company’s core business continues to grow well along with its acquired companies except Monster. Given the superior quality of Quess’ general staffing business, IT staffing, Facility management and GTS business segments, we feel that the stock deserves better valuations.

View and Valuation:

Quess has registered ~36% revenue CAGR over FY17-20 while EBITDA has grown at 40% CAGR over the same period. Company continues to grow with organic and Inorganic routes with about 25 acquisitions since inception. Net profit has posted 28% CAGR due to higher finance cost. Quess has acquired companies at reasonable valuations and then turned around well. Constant inorganic expansion has resulted in 50% CAGR in revenues over FY11-20. Quess has huge advantage of scale in general staffing with largest market share in India. It’s a pure bet of an asset-light business model with presence across varied business where the opportunity size is mammoth. In longer term, we believe, it is a unique integrated business model with a strong multi-decade compounding growth visibility.

We believe that FY21 would be a tough year for the company given Covid related disturbances. We think that margin for the year could see moderation and so on profitability. We project 7%/14% revenue/EPS CAGR over FY20-23E. We think that the company would return to normal business environment from FY22 onwards. Regulatory easing in the labor markets could result in structural decline in hiring / compliance / workforce management costs in the formal sector. Over the medium to long term, this should translate into higher formality in the labor market. Sectors such as IT/ITES, BFSI and Retail would in turn drive a higher need for flexi/temp staffing. Accordingly, we believe organized players like Quess, TeamLease etc. would be the key beneficiaries of these reforms. Continuous strengthening of balance sheet and improvement in corporate governance remain key re-rating triggers.

Substantial improvement in EBIDTA margin and thus profitability would be a key lever for the stock in the medium term. Management has maintained its thrust on improving cash flows and strengthening the balance sheet in the medium term. In Q4FY20, the company paid higher tax as it has now decided to move to the new tax regime offered under section 115BAA. As both the central and state governments look forward to liberalizing and formalizing the labor markets, Quess should be among the biggest direct beneficiaries. Factors such as (1) Formalisation of jobs, (2) Vendor consolidation, (3) Focus on collect & pay (4) Cost-cutting by Enterprises, and (4) Client diversification will benefit market leaders like Quess Corp. Efforts by the management to resolve capital allocation issues will be appreciated by investors. Financial deleveraging should aid fast growth in earnings. At CMP, Quess trades at ~26x FY22E earnings and 20x FY23E earnings (around 30% discount to Teamlease - negatives related to capital allocation are priced in). Quess’ valuations could re-rate as it simplifies its structure and balance sheet. We feel investors can buy Quess at LTP (26.5x FY22E EPS) and add on dips to Rs 483-489 band (24.0x FY22E EPS)) for base case fair value of Rs 587 (29.0x FY22E EPS) and bull case fair value of Rs 637 (31.5x FY22E EPS) over the next two quarters.

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