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Valuation factoring in long term growth potential

Demand outlook remains favorable, but margin pickup to take time

* TEAM delivered a strong operational performance in 2QFY22, with revenue up 10.7% QoQ on broad based growth across all three verticals. It also added 25k associates (record high) in 2Q, benefitting from a strong demand environment as well as seasonality and flow through from a COVID-impacted 1QFY22. EBITDA margin inched up by 10bp QoQ to 2.2% on strong growth in the Specialized Staffing business and partial drawdown in General Staffing, while HR Services broke even. Higher D&A resulted in flat EBIT margin, which missed our estimate.

* Despite the strong business performance, TEAM reported an adjusted loss of INR493m on account of loss provisions in its PF trust on DHFL investment resolution. This provision was surprising as TEAM had earlier maintained that reserves and future gains will compensate for any shortfall. While we view this as a one-time hit, this is likely to impact investor confidence.

* The management remains positive on growth, as a supportive macro and new logo additions boosts associate demand. We expect the company to report good revenue growth in all verticals on continued improvement in General Staffing, pick-up in HR Services, increased manpower demand, and higher margin replacements in the IT Staffing business.

* With the management expecting a flat margin over the next few quarters due to higher costs and stable PAPM, the growth momentum in earnings will be a more reasonable 28% over FY20-23E.

* While we remain positive on the medium- to long-term opportunity for TEAM, as it should benefit from formalization of the labor market, we view the current valuation as rich and hence downgrade the stock to Neutral.

* We are lowering our FY22E/FY23E estimate by 66/6% to factor in lower margin. Our TP of INR4,320/share implies 42x FY23E EPS.

Strong growth and employee additions; one-time hit on PF provisions

* Revenue grew 35% YoY (est. +32%) to INR15.2b. EBITDA grew 48% YoY (est. +43%) to INR342m. Adjusted PAT grew 19% YoY (est. +45%) to INR257m.

* For 1HFY22, Revenue / EBITA / PAT grew by +28%/34%/29% YoY.

* Revenue growth, at 11% QoQ, was a little above our estimate of 9% QoQ. Growth was broad based with General Staffing (+10% QoQ), Specialized Staffing (+17%), and Other HR Services (+13%) all posting strong growth.

* EBITDA margin inched up 10bp sequentially to 2.2% due to higher revenue growth in the Specialized Staffing business (higher margin), which was in line with our expectation.

* Adjusted PAT rose 19% YoY to INR257m. The same was lower than our estimate on higher tax and lower other income.

 * In 2QFY22, the company created a provision of INR750m with respect to a PF trust, which led to a net loss of INR493m.

* Associate headcount grew by 11% QoQ to 252k.

* Net addition is at a record high at 25k. Associate addition in General Staffing stood at 14k. Specialized Staffing had a net associate addition of 900. NETAPP added 10k trainees in 2QFY22, a record high.

* It added 204 new logos in 2QFY22.

* The NETAP business had the highest ever net additions at 10k apprentices.

Key highlights from the management commentary

* The company added 59 new logos, with strong topline growth and margin improvement. It saw strong additions of 14k in General Staffing and 25k overall. It registered an 11.5% growth in consultants and 10k new hires in NETAP.

* Increased headline billing, wage hikes, and a rising insurance bill will weigh on margin in the short term.

* HR services delivered strong growth and broke even in 2QFY22. The management expects it to contribute meaningfully to profit in coming quarters.

* It created provision totaling INR750m on account of the closure of DHFL, with 48% recovery (original maturity CY27) and interest shortfall in the PF book.

Valuation and view – a key beneficiary of formalization

* Given the level of uncertainty in the economy (due to the back and forth on lockdowns), some of the otherwise permanent roles are likely to be fulfilled through flexi-staffing, as employers attempt to maintain variable costs. We noticed similar trends in the immediate aftermath of the GFC and demonetization, when Staffing companies benefitted due to positive hiring trends in some verticals. Such a trend should play out in the near term, benefitting Staffing firms such as TEAM.

* Over the medium term, as both the Centre and state governments look to liberalize and formalize the labor market, TEAM should be among the biggest direct beneficiaries.

* We are lowering our FY22E/FY23E estimate by 66/6% to factor in lower margin. Our TP of INR4,320/share implies 42x FY23E EPS.

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