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Another strong show Strong growth and commendable profitability management

* Persistent Systems (PSYS) reported 2QFY25 revenue of USD345.5m, +5.3% QoQ in USD terms, above our estimate of ~+4.6% QoQ. It reported CC growth of 5.1% QoQ. EBIT margin stood at 14%, above our estimate of 13.6%. EBIT grew 5.8% QoQ/22.8% YoY to INR4.1b. PAT came in at INR3.2b, up 6.1% QoQ/23.4% YoY, in line with our estimate of INR3.2b. For 1HFY25, revenue/EBIT/PAT grew 19.0%/16.7%/16.8% vs. 1HFY24. We expect revenue/EBIT/PAT to grow by 20.2%/23.9%/23.2% YoY in 2HFY25. TTM TCV was USD529m, up 14% QoQ and 10% YoY (1.5x book-to-bill).

Our view:

* Continues to grow faster than the rest of the market: Despite a slowdown in its key vertical, PSYS has continued to grow at a breakneck pace of 20.1% YoY this quarter; both healthcare and BFSI contributed to the growth. PSYS's presence in high-growth verticals provides it a natural advantage and is one of the key reasons why it secures the no. 1 rank in our IMPACT framework analysis in our Sep’24 thematic report (Technology: Bounce-back! Charting the path to revival for IT services).

* Margins management commendable: PSYS's margins and the one-offs have been an area of intense focus. This quarter, PSYS managed to maintain flat margins despite headwinds such as wage hikes (210bp), ESOP costs (60bp), and the absence of one-off benefits (130bp); the headwinds were offset by utilization gains (120bp), pricing (130bp), lower sub-con cost (70bp) and other gains such as visa, forex, and lower pass-through (140bp).

* We have written earlier in our 6th Sep’24 PSYS management meet note as well; despite one-off gains, the company has enough operational levers to pull: utilization levels are comfortable and could go higher, SG&A investments are now behind, and subcontracting costs (thanks to the healthcare deal ramp up) are bound to come down.

* The management continues to prioritize growth and wallet share gains, and we believe this is the right strategy.

* Hi-tech to join the party: We are seeing the foundations of a recovery in hi-tech in commentaries this earnings season, and PSYS corroborated the same. This gives PSYS an additional growth tailwind, and we expect growth rates across the three key verticals to converge going forward. Valuation and changes to our estimates

* We project a 19% USD revenue CAGR over FY24-27E for PSYS, which, combined with margin expansion, could result in a ~21%+ EPS CAGR. This positions PSYS in a league of its own as a diversified product engineering and IT services player, justifying a premium valuation multiple.

* Our estimates are largely unchanged. The stock is currently trading at an admittedly expensive valuation. That said, owing to its superior earnings growth trajectory, on a PEG basis, we believe the valuation still has room for upside. We value PSYS at 50x Sep’26E EPS. Reiterate BUY with a TP of INR6,300

Revenue and margins beat estimates; healthcare and BFSI lead the charge

* 2QFY25 revenue stood at USD345.5m, up 5.3% QoQ in USD terms (above our estimate of 4.6% QoQ). It reported CC growth of 5.1% QoQ.

* Growth was broad-based across the US and Europe and was led by both healthcare (up 9.6% QoQ) and BFSI (up 7.7% QoQ). Hi-tech was again flat QoQ.

* EBIT margin at 14% was flat QoQ, and above our estimate of 13.6%.

* TTM TCV was USD529m, up 14% QoQ and 10% YoY (1.5x book-to-bill; in line with average for past 2 years).

* Net new TCV was up 25% QoQ at US389.8m. ACV stood at USD348.3m.

* Net headcount declined by 1.2% QoQ. Utilization was up 270bp QoQ at 84.8%. TTM attrition was flat QoQ at 12%.

* The top 5 clients witnessed growth of 7.7% QoQ, whereas the top 10 clients grew 5.3% QoQ.

* EBITDA grew 5.6% QoQ/18.6% YoY to INR4.8b and EBITDA margin came in at 16.6%, below our estimate of 16.2%.

* Adj. PAT stood at INR3.2b (up 6.1% QoQ/23.4% YoY), in line with our estimate of INR3.2b.

Key highlights from the management commentary

* The demand environment is pivoting based on market needs. The company is strategizing itself as a platform-driven business, utilizing AI solutions.

* All verticals are expected to see secular growth over the next couple of quarters. HLS is a non-discretionary spend vertical; this more resilient sector has been able to deliver growth.

* Winning new deals and offshoring mitigated the deflationary impact on revenue.

* Client decision-making on discretionary spending: deal wins span various sectors, focusing on setting up platforms for clients, which is revenue-bearing and not discretionary spending.

* Launching the T100 program—an initiative focused on the top 100 clients, designed to drive enhanced customer value, deepen customer intimacy, and unlock the next wave of opportunities for PSYS and its clients.

* Incremental levers for margin expansion include maintaining utilization at 83- 85%, significant investments in SG&A (with a slower pace going forward), right shoring, and pricing growth momentum, all of which will help improve margins.

Valuation and view:

* Our estimates are broadly unchanged. The stock is currently trading at an admittedly expensive valuation. That said, owing to its superior earnings growth trajectory, on a PEG basis, we believe the valuation still has room for upside. We value PSYS at 50x Sep’26E EPS. Reiterate BUY with a TP of INR6,300.

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