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Expect growth recovery to continue in FY22

Provisioning impacts 4QFY21 earnings

* Quess Corp (QUESS)’s 4QFY21 results were operationally in line with our expectations, as revenue recovered to 4Q FY20 levels. This was led by recovery in all segments – Workforce Management (-1% YoY), Operating Asset Management (+9% YoY), and Global Technology Solutions (+1% YoY).

* Quess took one-time provisioning of INR1.2b in 4Q (830m in Trimax + 360m in skill development) on account of delay in receivables in government business. Excl. this, EBITDA margin was in line at 5.2%. Adj. PAT – excluding provisions and a one-time deferred tax liability charge on goodwill of INR520m (due to tax law changes) – was INR1.1b (v/s our estimate of INR779m). The beat on PAT was primarily led by tax reversal in 4Q.

* Quess continued its recovery from the impact in 1HFY21 on account of a tough lockdown. YoY improvement is expected in 1QFY22 despite the slowdown due to lockdowns since late March (on account of the second COVID wave). We expect the company to return to sequential growth from 2Q as the economy opens up gradually, aiding the General Staffing business. Continued demand for IT staffing should further aid growth.

* We expect QUESS to deliver 22% revenue growth in FY22E after a flat FY21, partially aided by a low base. It should also see a gradual increase in the EBITDA margin (+50bp YoY in FY22E on improving efficiency and a shift towards the higher margin IT Staffing business) and higher interest income from continued cash additions – this would help the company deliver a 3.4% PAT margin v/s flat adj. growth in FY21.

* We also see the announcement of a new dividend policy – payout of 33% of FCF over three years – as a positive, especially as this indicates the management is comfortable with the cash generation ability. This further strengthens the view on the digestive strategy by Quess (rather than acquisitive) and indicates increased focus on cash flow. The company has also guided for minimum 70% OCF/EBITDA for FY22, along with reiterating its aim to deliver 20% ROE in FY23.

* Over the medium term, we expect QUESS to be a big beneficiary of the recent labor law reforms. Our TP of INR820 per share implies a multiple of 18x FY23E EPS. Reiterate Buy.

In-line operating performance; provisioning impact on 4QFY21 PAT

* Revenue was flat YoY at INR30b (in-line). EBITDA fell 7% to INR1.6b (in-line). Adjusted PAT rose 80% YoY to INR1.1b (est. +24%). Revenue / EBITDA / adjusted PAT declined 1.4%/12%/18.5% in FY21.

* Revenue was up 7% QoQ, driven by General Staffing / IFM / Industrials (up 11%/6%/11%). On a YoY basis, revenue remained flat (in-line).

* The adjusted EBITDA margin stood at 5.2% (-20bp QoQ and -40bp YoY; est. 5.3%). This excludes a one-off provision of INR1.2b on account of delay in government contract payments/timelines due to the ensuing COVID lockdown.

* Lockdown-related loss from the Training and Skill Development and Food businesses amounted to INR200m in 4QFY21. Adjusted for this, EBITDA would be up 5% YoY.

* Adjusted PAT increased 80% YoY to INR1.1b (est. INR779m). This was aided by tax reversal of INR251m.

* Headcount in General Staffing grew 13% QoQ, with the core-to-associate ratio at a historical high of 347.

* Gross debt fell to INR5.2b (from INR11.5b) on the back of cash management, improved collections, and income tax refund. The company currently has a net cash position of INR1b.

Key highlights from management commentary

* Trimax still owes INR1b at the end of FY21, and the management stated that further provisioning for the same would not be required. In addition to this, total receivables from the government business stand at ~INR2b.

* While near-term pressure due to the second COVID wave led lockdown would impact business in 1Q, the management is confident of a pickup as the economy recovers. The management aims to achieve 20% growth in FY22 in all of the business segments. After hitting the bottom in the Workforce Management segment, the management expects margins to expand as the high-margin business returns to previous levels.

Valuation and view – company-level improvement to drive re-rating

* Given some amount of uncertainty in the economy (due to back-and-forth lockdowns), some of the otherwise permanent roles are likely to be filled through flexi-staffing as employers attempt to keep cost variable. We noticed similar trends in the immediate aftermath of the GFC/demonetization – when staffing companies benefitted from positive hiring trends in certain verticals. Such a trend would likely play out in the near term, benefitting business services firms such as QUESS.

* Over the medium term, as both the center and state governments look to liberalize and formalize the labor markets, QUESS should be among the biggest direct beneficiaries.

* We welcome the corrective steps taken by the new management to address some of the investor concerns. The improvement in cash conversion / RoE should drive a re-rating. Our TP implies 18x FY23E EPS.

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