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Our Take:

Firstsource Solutions Ltd (FSL), a formidable player in the business process management space, has been consistently focusing on three high growth industry segments - BFS, Healthcare and CMT (Communication, Media and Telecom) across North America and the UK and has been systematically investing in building capabilities and expanding client base in the born-digital as well as new-age client segments of these industries.

These include FinTech, HealthTech, Streaming and Digital media. The company posted robust Constant currency (CC) growth of 31.7%/23.8% YoY in Q4FY21/Q3FY21. EBITDA expanded 210bps to 16% in Q4FY21 from 13.9% in Q2FY19. For the entire year FY21, it reported a stellar 17.9% organic growth after years of underperformance along with sharp uptick in its return ratios and cash collections.

As far as FY22 growth guidance is concerned, the company has guided for revenue growth of 15–18% in CC terms with a normalized EBIT margin of 11.8–12.3%. Post the revamp in top management in FY20 when Mr. Vipul Khanna joined as a new CEO & MD (Ex-Cognizant), the business strategy was to fill the gaps in existing offering.

Strong performance for FY21 along with aggressive growth guidance for FY22 reinstates our positive view on the company. FSL has seen healthy client wins of 11 new clients in Q4FY21 and 54 in FY21. It has also witnessed healthy headcount addition (up ~3x in FY21 - 6801 net additions in FY21 v/s 2491 in FY20) indicating robust demand in coming quarters.

FSL continues to focus on efforts to improve sales momentum on a continuous basis and its renewed strategy augurs well towards adding stability and drivers to revenue profile. FSL is well positioned to strengthen client’s business processes, increase productivity and drive revenue growth with expertise in Analytics, Intelligent Automation (IA), Agent Productivity and enhancing customer experience.

This expertise will prove to be beneficial to drive operational efficiencies, gaining market share and maintaining relationship with customers. Company has a diversified, well-balanced portfolio along with geo-delivery mix and continued focus on digital.

On 26 Oct, 2020, we had initiated coverage report on Firstsource Solutions Ltd and recommend to buy at LTP at Rs 73.4 and add further on dips to Rs. 65 for base case target of Rs 82 and bull case target of Rs 89. The stock has achieved its both targets in Dec 2020. Given healthy growth outlook and strong set of numbers in Q4FY21, we have now revised earnings and increased target price for the stock.

Valuation & Recommendation:

FSL is a provider of a range of business process management services across the customer life cycle delivered through transaction processing. The company is focused on industries like Banking & Financial Services, Healthcare, Communications, Media & Tech. These industries are engaged with structural changes brought about their technology, changing consumer preferences, regulatory policy and off late macroeconomic factors catalysed by the pandemic.

We expect, FSL’s revenue/PAT to grow at a CAGR 16.7/36% over FY21–23E which will be mainly driven by 1) new logo-wins in BFS, media and technology 2) higher contribution from top clients 3) recovery in mortgage business, and 4) improved traction in UK BFS & retail business. Segment-wise, we expect BFSI (contributes ~50% of revenues) to continue to lead with accelerated growth over FY21-23. Going forward, we expect consistent improvement in return ratios which will be on the back of better free cash flow generation and higher dividend payout.

We believe that expected acceleration in revenue growth momentum, stability in margins, strong consistent execution, delivery on guidance and strong cash generation would support valuations. We believe the base case fair value of the stock is Rs 173 (18.0x FY23E EPS) and the bull case fair value of the stock is Rs 187 (19.5x FY23E EPS) over the next two quarters. Investors can buy on dips to Rs 147-151 band (14.5x FY23E EPS) and add further on dips in the Rs 132-136 band (14x FY23E EPS). At the LTP, the stock is trading at 17.1x FY23E EPS.

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