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Record bookings to drive FY24E growth…

…but valuations adequately factor in strong growth; retain Neutral

* Persistent Systems (PSYS) reported a 3.5% growth in constant currency (CC) terms in 3QFY23. In USD terms, revenue grew 3.4% QoQ led by strong growth in IP business (+8.6% QoQ) while growth in services was lower at 3.0% QoQ. EBITDA margin was strong and stood at 18.5% (est. 17.9%). Employee addition was modest (+122 QoQ), while attrition moderated 210bp to 21.6%.

* The company’s performance in Services (+3% QoQ) moderated due to furloughs and ramp-down by a top client. PSYS expects a revival in top client growth over the next few quarters, which together with record TCV (USD 440m, book-to-bill ratio of 1.7x) should aid topline growth amid a weakening macro environment. Its ability to win new deals is encouraging and should help deliver another year of industry leading growth.

* Strong deal pipeline, traction in cost-take-out deals and likely bounce back in top client growth should cushion any moderation in discretionary spends. We expect PSYS to deliver a top tier revenue growth among our midcap IT Coverage Universe (21% CAGR over FY22-25E).

* Given the operating leverage, strong fresher addition and improving metrics, PSYS should be able to maintain margin at current levels in FY24 before improving it in FY25. We expect an EBIT margin of 15.3%/15.5% for FY24/25 and FY22-25 PAT CAGR of 26%.

* PSYS is trading at a rich valuation of 28x FY24E P/E and on the higher side of the Midcap IT median valuation. It adequately factors in favorable growth and demand environment. Hence, we maintain our Neutral rating with a TP of INR4,360 as we see limited upside from current levels.

* We raise our FY23/FY24/FY25 EPS estimates marginally by ~3%-6% on strong performance. We value the stock at 28x FY24E EPS..

In-line revenue, strong TCV in 3QFY23

* Revenue/EBIT/PAT up 33%/60%/52% YoY, respectively, in 3QFY23.

* USD Revenue/INR EBIT/INR PAT grew 39%/58%/41% YoY, respectively, in 9MFY23.

* USD revenue rose 3.5% QoQ CC to USD264.4m (in line). Reported USD growth was 3.4% QoQ.

* EBITDA margin stood at 18.5% (+50bp QoQ), 60bp above our estimate on low employee additions (+122 QoQ) and cost efficiencies.

* Adj. PAT grew 21.6% QoQ to INR2.7b v/s our estimate of INR2.5b.

* Utilization was down 230bp. TTM attrition contracted 210bp QoQ to 21.6%.

* Cash and investments stood at INR16.7b (v/s INR15.7b in 2QFY23).

* PSYS declared an interim dividend of INR28 per share

Key highlights from the management commentary

* Though the company’s top account moderated 12% QoQ, it has bottomed out and the management expects it to bounce back.

* The second largest client saw furloughs in 3QFY23; however, growth should remain healthy going forward.

* PSYS aspires 200-300bp margin improvement in the medium term. Margin levers include freshers, client mining (which will optimize SG&A) and IP that will allow PSYS to grow faster.

* It is actively evaluating businesses for tuck-in capability acquisitions

Improvement in growth already priced in; maintain Neutral

* Historically, execution challenges and volatility in the IP portfolio led to inconsistency in PSYS’ performance. However, we have noticed steady progress on the execution front after the changes in management and strategy.

* This is evident from the Services segment’s healthy and industry-leading performance over the past few quarters. We expect a higher emphasis on annuity revenue to address the inconsistency issue to some extent.

* The company’s: 1) strong performance in recent years, 2) healthy order book, and 3) strong deal pipeline indicate an encouraging demand trend.

* The stock is currently trading at 28x FY24E EPS. Our TP is based on 28x FY24E EPS. We reiterate our Neutral rating as we believe the positives have already been captured and the stock offers limited upside from current levels.

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