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Valuations offer a cushion against macro concerns

Targets mid-teen margin by mid-FY24

ZENT remains cautious given the weakening demand, especially from Retail, Manufacturing, and Technology, while the same from BFSI remains good. The management, at RPG’s annual investor conference, said it is aiming at mid-teen margin by 2QFY24. It also has a good M&A pipeline, with five deals on the table.

Expect some impact on demand from a weakening macro

* The management is seeing signs of a softening in demand from clients.

* There is a visible slowdown in Retail, Manufacturing, and Technology. Tech companies have started to lay-off employees.

* As the business at large retailers is shifting towards cost-efficiency work, ZENT aims to be selective in its approach to avoid aggressive pricing behavior.

* Demand and order book from the BFSI space remains strong, given the Fed’s stance on interest rates. The management said the demand environment is similar to CY06.

* It has recently hired Mr. Manikandesh Venkatachalam (formerly with MTCL) to spearhead ZENT’s five strategic growth opportunities.

* In terms of geographies, Africa remains strong, although depreciation in the currency has acted as a drag for ZENT.

* It also has a good M&A pipeline, with five deals on the table.

Strong execution to drive margin improvements

* Operating margin was impacted due to higher attrition, with replacement cost at 1.5-2.5x. The lack of a fresher program had an additional impact on margin.

* It hired 1,600 freshers in FY22. Higher sub-contractor costs and an increase in its bench strength, due to the training period, acted as a drag on margin.

* The management aims to push margin back to the mid-teens by 2QFY24.

* It highlighted six margin levers, led by an improvement in: 1) the service mix, 2) commercials (securing good price hikes), 3) utilization, and optimization of the 4) employee pyramid (hiring more junior staff), 5) support costs, and 6) cost of talent acquisition.

* ZENT offered its best-ever wage hike in Jul’22, which is helping cool attrition. It aims to pare down attrition to 22% over the next two-to-three quarters.

* Pressure on the supply-side will continue for some time, given the elevated industry pressure on account of: a) the drying up of supply from Eastern Europe, b) demand from captives, c) startups, and d) lack of trained supply. This is likely to delay the normalization of supply.

Valuation and view

* ZENT’s current valuation (12x FY24E EPS) is one of the lowest in our midcap coverage.

* We expect a continuation in the revenue growth momentum in FY23. The new CEO-led leadership team is in place and its growth strategy has delivered results. The management expects margin to revert to the high teens over the medium term. With strong organic growth in FY23 and a recovery in key accounts, we see potential for a significant stock re-rating as valuations catch up with its peer group. Our TP implies 14x FY24E EPS. We maintain our Buy rating on the stock.

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