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Datamatics Global Services Ltd. reported disappointing revenues at INR3,768mn (below our estimates), down 3.7% QoQ but up 9.7% YoY. The decline was due to premature closure of a project in Consumer & Retail space and slowdown in client decision making. The topline growth YoY was broad based across the three business segments with Digital Operations segment growing 15% YoY. The company reported EBIT of INR496mn, down 15.4% QoQ but up 15.7% YoY. Reported consolidated PAT stood at INR493mn (+23.3% YoY). The company added 15 new clients in Q2FY24. It has a robust pipeline of $290mn, up 99% YoY.

* Investment in AI first capabilities: DGSL has integrated Generative AI capabilities into their Intelligent Automation products, consisting of TruBot, TruCap+ and TruBI. They have launched a range of GenAI-powered solutions, such as Enterprise Content Mining, Virtual Assistants, Financial Data Analytics, and Revenue Operations. They are also showcasing them at some of the World's leading IT shows across the US and Europe. Management is constantly incorporating AI in their Technologies, Operations, Experiences, and Products businesses. DGSL introduced FINATO (powered by AI) in Q2 to drive Finance Transformation in global enterprises. Management believes that contribution from AI shall increase in upcoming years and shall drive significant growth.

* Digital Operations segment gaining more share: The company reported that the Digital Operations segment gained more share, with a revenue mix of ~44% compared to ~42% in Q2FY23. The segment's revenue stood at INR1,646mnn, down 1.4% sequentially but up 15.0% YoY. Revenue for the Digital Experiences segment stood at INR585mn, accounting for 15.5% of the revenue mix in Q2FY24, compared to 15.3% in Q2FY23. The premature closure of a project took place in this segment and hence it affected its revenues and margins. The Digital Operations segment had higher EBIT margins of 18.6% compared to the Digital Experiences segment's reported EBIT margin of 17.5%. The Digital Technologies segment reported a revenue of INR1,537mn and an EBIT margin of 5.7% for the quarter. Management expects its margins to be in the range of 7-8% for FY24E.

* Margin improvement visibility: Operating margins for Q2FY24 stood at 13.2%, down 183bps QoQ but up 68bps YoY. The decline in margin can be attributed to the premature closure of a project of a top 10 client. The management has claimed it has been able to renegotiate its prices with several customers which shall aid margin growth. It expects the full scale impact of price hike to be witnessed in FY24E.

* Outlook and Valuation: Robust pipeline, introduction of FINATO, push towards AI first and organizational re-shuffling are identified as the growth drivers. However, given the macro-environment challenge and delays in discretionary spending, it has withdrawn its guidance of 14-15% for FY24E. Management expects Q3 to be softer and Q4 to be the strongest due to cyclicality and is confident on seeing ramp ups from the client who prematurely closed the deal. We have introduced FY26E and expect Revenue/EBIT/PAT CAGR of 13.9%/16.8%/16.8% resp. over FY23-FY26E. We maintain ADD to arrive at a target price of INR650 implying a P/E of 14x on SeptFY26E EPS of INR46.

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