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Strong performance continues, valuations rich

Demand intact, margin stable

* PSYS posted a strong 1QFY23. In USD terms, revenue grew 11.1% QoQ (160bp above our estimate, an organic growth of 5.6% QoQ). EBITDA margin stood at 17.7% (est. 16.9%). It reported a TCV of USD394m, with 58% new business TCV. Employee additions, at 3,039, were the highest ever, despite an elevated attrition rate of 26.3% (down 30bp QoQ).

* The company maintained a strong performance in Services (+13.5% QoQ) and demand outlook. It also delivered its highest TCV, with a book-to-bill ratio of 1.6x. PSYS’ capability to win new deals is encouraging and should result in its sustained industry-leading growth in FY23.

* A strong order book and robust pipeline should allow PSYS to deliver a USD revenue growth of 35.8% in FY23, despite a higher base in FY22 (up 35% YoY). With a strong demand commentary and deal momentum, we expect PSYS to deliver top tier revenue growth among our midcap IT Coverage Universe (26% of over FY22-24E).

* The management acknowledged that while attrition (LTM) looks concerning, it has started to stabilize on a quarterly (annualized) basis and should moderate in coming quarters.

* It remains confident of maintaining margin at current levels in the near term, with the help of utilization, lower sub-contractor expenses, fresher additions, and lower ESOP costs. We expect an EBITDA margin of 17.3%/17.8% in FY23/FY24.

* PSYS is now trading at 24x FY24E P/E, which is on the higher side of the Midcap IT median valuation and appropriately factors in favorable growth and demand environment. Hence, we maintain our Neutral rating as we see limited upside from current levels.

* We raise our FY23/FY24 EPS estimate marginally (up 2.5%/4.9%) on better revenue growth and margin. We value the stock at 25x FY24E EPS.

Strong broad based performance in 1QFY23

* Revenue/EBIT/PAT grew 45%/55%/33% YoY in 1QFY23. ? USD revenue rose 11.1% QoQ to USD241.5m, 160bp above our estimate.

* EBITDA margin grew 50bp QoQ to 17.7%, 80bp above our estimate due to operating leverage. ? PAT grew 5% QoQ in INR2.1b (in line) on lower other income.

Key highlights from the management commentary

* PSYS posted its highest ever TCV of USD394m in 1QFY23. It is seeing early wins in new acquisitions.

* There is no cut in spends or impact on demand due to the current macro situation.

* Given the current macro situation, clients have accelerated cost rationalization initiatives. PSYS won multiple large deals on account of its cost optimization initiatives.

* Though there will be 250-300bp margin impact in 2Q on account of wage hikes, the management is confident of delivering full-year margin comparable to FY22 levels on account of higher utilization, lower sub-contractor expenses, pyramid rationalization as freshers get deployed, and lower ESOP costs in the later part of FY23.

Improvement in growth already priced in

* 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 change 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 FY21 and FY22, 2) healthy order book, and 3) strong deal pipeline indicates an encouraging demand trend. The management aspires to attain a revenue run-rate of USD1b over the next few quarters, which is a key positive. It said it will defend margin in the near term and will expand it in the long term.

* The stock is currently trading at 24x FY24E EPS. Our TP is based on 25x 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

Highlights from the management commentary Growth and demand outlook

* PSYS delivered yet another strong 1QFY23, reporting a revenue growth of 11.1% QoQ and 44.8% YoY. Of this, revenue growth of 5.6% QoQ was organic in nature.

* The company posted its highest ever TCV of USD394m in 1QFY23. It is seeing early wins in new acquisitions.

* Growth was broad based across all verticals, led by BFSI. All client buckets grew well, depicting improved confidence in PSYS’ account mining capabilities.

* Growth in the company’s top account moderated 7.1% QoQ on account of the restructuring of an IP deal.

* IP-led revenue was soft due to lower royalty income and restructuring in the top client.

* The management expects the growth momentum to continue in the Services business.

* Order book remains strong and broad based with good portion of executable order book. The deal pipeline remains strong, which is likely to keep the growth trajectory elevated.

* There is no cut in spends or impact on demand due to the current macro situation.

* Given the current macro situation, clients have accelerated cost rationalization initiatives. PSYS won multiple large deals on account of its cost optimization initiatives.

Margin performance and outlook

* EBIT margin stood at 14.3% in 1QFY23. There was a 30bp improvement in margin, despite higher amortization, travel, and visa costs on account of a favorable forex rate (aided margin by 90bp).

* Other income was lower on account of: 1) the set-off of interest as trust accounts got consolidated, 2) lower funds used for acquisitions, and 3) MTM losses in mutual funds.

* Though there will be 250-300bp margin impact in 2Q on account of wage hikes, the management is confident of delivering full-year margin comparable to FY22 levels on account of higher utilization, lower sub-contractor expenses, pyramid

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