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Strong Q3 delivery; margin pickup in FY25 to drive rerating

Improved margin levers offset by one-off impact in 3Q

* TEAM’s 3QFY24 revenue growth of 22% YoY was ahead of our estimate. Revenue growth was led by 17% YoY growth in General Staffing (+23% YoY) and Specialized staffing (+12% YoY), while other HR services was up only 10% YoY (down 14% QoQ), due to Edtech revenue deferrals during the quarter. Specialized staffing growth was led by GCCs in 3Q. The company reported an EBITDA margin of 1.5%, ahead of our estimate of 1.4%, primarily due to higher margins in other HR services. Despite improvement in PAPM and better productivity, General Staffing margins moderated 5bp in 3Q due to the one-off impact of bonus disbursements.

* General staffing performance in 3Q exhibited a mixed trend, with betterthan-expected growth, but a weaker margin profile (partially due to one-off employee bonuses impacting the revenue base). Moreover, the modest addition of 7.4k associates was attributed the company’s focus on highermargin services.

* While we continue to see robust demand in general staffing, margin improvement will be a gradual process (FY25 general staffing EBITDA margin to be up 15bp YoY). Additionally, the company should start seeing support from the recovery in DA programs, which had previously been a drag until the last quarter.

* Despite the strong growth in TEAM’s specialized staffing business during this quarter, we continue to factor in meaningful improvement only by 2QFY25, given the continued weakness in IT services ecosystem. We expect the specialized staffing recovery to be a key support for profitability recovery over the next two years. We expect consolidated revenue CAGR of 19% over FY23-26E for the company.

* On the other hand, margin recovery will be more gradual than initially expected, although we still see it contributing to earnings growth over FY25- FY26E. TEAM has started to rationalize its core headcount and is also trying to cross-sell and up-sell to improve its PAPM. We are building in FY25/FY26 EBIDTA margin at 1.7%/2.0%. This should translate to healthy earnings CAGR of 30% over FY23-26E.

* We remain positive on the medium- to long-term opportunities, owing to gains from the formalization of the labor market and reiterate our BUY rating on the stock. We marginally tweak our FY24-FY26 EPS estimates post 3Q results. Our TP of INR 3,450 implies 23x FY26E EPS.

Strong execution; beat on both revenues and margins

* Revenue growth for TEAM stood at 7.6% QoQ/21.8% YoY against our estimates of 17% YoY. Growth was led by General Staffing services, up 22.7% YoY. Specialized staffing was up 12.3% YoY/9.5% QoQ. Other HR services was down 14.0% QoQ due to Edtech revenue deferrals.

In 3Q, General staffing saw an addition of 7.4k associates, whereas specialized staffing headcount decreased 775. DA headcount witnessed an increase of 1.0k. The company expects the remaining NEEM trainees to fully attrite by 1QFY25.

* EBITDA margin stood at 1.5% in 3Q against our expectations of 1.4%. General Staffing EBITDA margin stood at 1.2% (Est. 1.3%) and Specialized staffing margin stood at 7.0% (est. 7.2%). Other HR services reported 11.7% margin (est. 6.5%).

* Adj. PAT at INR277m was down 5% YoY, against our estimate of INR287m due to higher interest cost.

* The company reported exceptional income of INR35.1m on account of PF trust reversals. Reported PAT stood at INR312m, up 7% YoY.

Key highlights from the management commentary

* The IT service sector continued to experience reduced hiring over the past several quarters, further intensified by the impact of furloughs in 3Q. This decline is partially offset by the uptick in hiring for GCCs and Product companies. Notably, 66% of the net revenue in 3Q is contributed by GCCs.

* In 3Q, hiring was primarily driven by the Manufacturing vertical, with some early signs of ramp-up observed in the BFSI sector. However, the management maintains cautious optimism for at least the next two quarters in BFSI.

* In the EdTech sector, the management expects a 30% YoY growth with an EBITDA margin ranging from 8-10%. For HR Tech, it expects a growth of 20%, and it might breakeven with marginal productivity in FY25. Overall, it expects another quarter of growth, partly aided by GCC and a healthy deal pipeline for other businesses.

* Generalized staffing EBITDA margin was adversely impacted by the transition mandates of low margin telecom staff. Additionally, the company disbursed a one-time bonus in 3Q, which had a bottom-line impact of INR10m.

Valuation and view - A key beneficiary of formalization

* Due to concerns about growth moderation and margin pressure, the stock has seen a significant de-rating in the recent past. We believe that valuations have bottomed out and already factor in near-term downsides.

* As both the central and state governments look to liberalize and formalize the labor market, TEAM should be among the biggest direct beneficiaries in the medium term.

* Strong growth and expected margin recovery should help TEAM deliver a 19% earnings CAGR over FY24-26, which should drive a significant re-rating in the stock. We reiterate our BUY rating on the stock with a TP of INR3,450, implying 23x FY26E EPS.

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