IGI Logo

Growth recovery firmly on track

Performance to drive a further re-rating

* ZENT reported a strong 1QFY22, with a USD CC revenue growth of 4.8% QoQ, led by Hi-Tech and BFS clients. With the planned increase in S&M spends by the company, EBIT margin declined by 90bp QoQ to 13.9%. While deal TCV (USD97m, 0.8x BTB) in 1QFY22 was meaningfully below its historical run-rate, the company has changed its process of deal win recognition, making the comparison less relevant.

* ZENT’s solid 1QFY22 performance reinforces our view that its new sales-led strategy should help it return to mid-teen growth in FY23E. We estimate organic CC growth of 15.1% in FY23E, after a higher single-digit growth in FY22E (partially due to an adverse base). A good exit to FY22, in addition to a recovery in key accounts should also aid growth going forward.

* While higher investment in sales and return to a normal wage cycle (from Jul’21) will impact FY22E EBITDA margin (-120bp YoY), we see this as a necessary investment, which should yield returns in the form of a sustainable growth performance. Moreover, this should start normalizing in FY23E as the upfront investment in sales stabilizes and growth picks up. We expect ZENT to deliver 21% PAT growth over FY21-23E.

* We also see higher downside protection in the share price at current levels, as 15% of ZENT’s market capitalization is in cash v/s only 8% for its midcap IT Services peers. A strong cash balance also offers incremental growth from tuck in acquisitions in coming years.

* The company’s relatively low valuation (18x FY23E P/E) is primarily on account of its weak topline performance over the last two years. While valuations have inched up in the past three months, it is in line with the broader midcap IT universe, and hence remains at a steep discount to peer group median of 27x FY23E EPS. We continue to expect this to narrow with a pick-up in growth over the next few quarters.

* We have increased our FY22E/FY23E earnings estimate by 7%/8% on better than expected performance and strong growth expectations in FY23E. Our TP implies 21x FY23E EPS. We maintain our Buy rating.

1QFY22 beat led by solid growth in Hi-Tech

* Revenue increased by 2% YoY to USD127m (est. flat performance), EBIT grew 33% to INR1.3b (est. +27%), and PAT rose 39% to INR1b (est. +26%).

* Revenue stood at USD127.2m, 5.8% QoQ above our expectation of 4% growth. In CC terms, revenue grew 4.8% QoQ.

* Revenue growth was led by a 13.5%/5.2% sequential increase in HiTech/BFS. Consumer Services came in flat, while Manufacturing/Insurance declined by 4.1%/2.2%.

* DAS/DFS grew by 6.4%/2.3% QoQ.

* EBIT margin stood at 13.9%, -90bp QoQ and 40bp above our estimate.

* The sequential decline in margin was due to a 140bp increase in SG&A and higher delivery charges, partially offset by exchange gains.

* PAT stood at INR1b (+11.6% QoQ), a 10% beat on our estimate, led by higher operating income and other income.

* 1QFY22 saw an increase in over USD20m/ USD10m accounts.  Strong net headcount additions of over 400 QoQ, led to a 90bp dip in utilization.

* Attrition inched up to 18.1% (+330bp QoQ).

* Revenue from the US increased 6.7% QoQ, while Africa reported a revenue increase of 9.5% QoQ. A partially flattish performance was seen in Europe.

* Revenue growth was led by the top five accounts, which saw an increase of 9.8% QoQ. Beyond the top 20, growth was restricted to 3.8% QoQ.

Key highlights from the management commentary

* Order book stood at USD97m in 1QFY22, with an equal mix of new deals and renewals. With the company pursuing a good number of logos, order book should increase going forward.

* Within verticals, Hi-Tech reported strong growth on the back of a steady recovery in its clients. The management expects this momentum to continue going forward. BFSI is expected to report robust growth in coming quarters.

* It expects margin to be at high teen levels over the medium to long term, while near term headwinds like investments into the business would lead to a decline.

Valuation and view

* ZENT’s current valuation of 18x FY23E is the lowest in our midcap coverage and is at a 30% discount to peer median valuation on FY23E EPS estimates.

* We expect revenue growth to rebound from 2HFY22E as a new leadership (Mr. Ajay Bhutoria took over in Jan’21), refreshed strategy, and reinvestment of margin gains in sales start paying off. With a likely return to double-digit growth in FY23E (est. 19% YoY) on a good FY22 exit and recovery in key accounts, we see a potential for significant stock re-rating as valuations catch up with its peer group.

* We also see higher downside protection in the share price at current levels, as 15% of ZENT’s m-cap is in cash v/s only 8% for its midcap IT Services peers. Our TP implies 21x FY23E EPS. We maintain our Buy rating.

To Read Complete Report & Disclaimer Click Here

For More Motilal Oswal Securities Ltd Disclaimer http://www.motilaloswal.com/MOSLdisclaimer/disclaimer.html SEBI Registration number is INH000000412

Above views are of the author and not of the website kindly read disclaimer