Firstsource 1QFY18
- 1. Anand Rathi Share and Stock Brokers Limited (hereinafter “ARSSBL”) is a full-service brokerage and equities-research firm and the views expressed therein are solely of ARSSBL and not of the companies which have been covered in the Research Report. This report is intended for the sole use of the Recipient. Disclosures and analyst certifications are present in the Appendix. AnandRathi Research India Equities Technology Company Update India I Equities Mohit Jain Research Analyst +9122 6626 6531 mohitjain@rathi.com Shobit Singhal Research Associate +9122 6626 6511 shobitsinghal@rathi.com Key financials (YE Mar) FY15 FY16 FY17 FY18e FY19e Sales (` m) 30,034 31,747 34,569 33,564 35,156 Net profit (` m) 2,345 2,650 2,800 2,671 2,757 EPS (`) 3.3 3.8 4.0 3.9 4.0 Growth (%) 19.0 13.1 5.6 -2.6 3.2 PE (x) 10.3 9.1 8.6 8.9 8.6 PBV (x) 1.2 1.0 1.2 1.0 0.9 RoE (%) 11.2 11.7 12.6 12.4 11.3 RoCE (%) 8.2 7.8 7.3 7.2 7.9 Dividend yield (%) - - - - - Net debt/equity (x) 0.4 0.3 0.4 0.2 0.1 Source: Company, AnandRathi Research ` Rating: Hold Target Price: `38 Share Price: `35 Key data FSOL IN / FISO.BO 52-week high / low `49bn / `30 Sensex / Nifty 32014 / 9979 3-m average volume $1.8m Market cap `24bn / $369.7m Shares outstanding 682m Shareholding pattern (%) Jun'17 Mar'17 Sep'16 Promoters 54.9 54.9 55.4 - of which, Pledged - - - Free float 45.2 45.1 44.7 - Foreign institutions 8.6 9.2 9.3 - Domestic institutions 6.4 6.8 6.0 - Public 30.2 29.1 29.3 Change in Estimates Target Reco 8 August 2017 Firstsource Solutions Growth sluggish; retaining a Hold With revenue at $132m (up 1.8% q/q, 1% y/y), incl. $6m from the sky deal (two-month further consolidation in Q1), Firstsource struggled organically (dollar revenue down 2.8% q/q, 3.8% y/y). This includes adverse currency movements (UK revenue: 41%, £-$ down 3.1% q/q). Margin performance at 8.6% was commendable (up 42bps q/q, down 290bps y/y), supported by reduced headcount (by 858 or 3.3%). We cut our FY18e/FY19e ~8%/ 5.5%, factoring in currency movements and the domestic business sale. Our new target is `38 (9x FY19e EPS). Slow growth and limited opportunities to improve margins. FSOL is now in a slow-growth phase with many verticals (BFSI: 27% of revenue, telecoms: 37%) reporting anaemic organic growth. The third vertical Healthcare (36% of revenue) is growing in mid-single digits but faces uncertainty (~1% of revenue) due to evolving regulations. Overall, FY18 may see weak dollar growth (1% y/y) with a 3.7% impact due to the sale of the domestic business, and another 1.3% impact from GBP movement. Given long-term hedging, other income will be high in FY18, protecting profits. Domestic business sale to pull up margins. FSOL sold its domestic BPM business (~6% of revenue) including transfer of 4,500 employees for an undisclosed sum. We have factored this into our estimates (proceeds estimated at $9m @ 0.35x revenue) and expect it to end FY18 with a 30bp higher EBITDA margin, excl. other income. Management believes that over FY17-19, a 70bp margin expansion is possible due to the sale. In reported terms at the company level, it has guided to 50bp margin expansion in FY18. Valuations. Factoring in the sale of domestic business and currency movements, we lower our FY18e/19e by 8%/5%. In Q1 FY18, other income constituted 40% of PBT, uncomfortably high. We slightly lower our target to `38 (9x FY19), and maintain our Hold call. Risks: M&A-driven growth, automation. Relative price performance Source: Bloomberg FSOL Sensex 30 35 40 45 50 55 60 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Estimates revision (%) FY18e FY19e Sales ($) (3.5) (4.5) EBITDA (9.8) (3.8) PAT (8.1) (5.5)
- 2. 8 August 2017 Firstsource Solutions – Growth sluggish; retaining a Hold Anand Rathi Research 2 Quick Glance – Financials and Valuations Fig 1 – Income statement (` m) Year-end: Mar FY15 FY16 FY17 FY18e FY19e Net revenues 30,034 31,747 34,569 33,564 35,156 Revenue growth (%) -4.0 5.7 8.9 -2.9 4.7 - Oper. expenses 26,538 28,254 31,176 30,184 31,270 EBIDTA 3,496 3,493 3,393 3,380 3,886 EBITDA margins (%) 11.6 11.0 9.8 10.1 11.1 - Interest 711 524 453 399 336 - Depreciation 722 662 590 630 698 + Other income 378 650 1,019 969 665 - Tax 95 302 577 649 759 Effective tax rate (%) 3.9 10.2 17.1 19.6 21.6 + Associates / (minorities) -2 -4 8 -0 -0 Adjusted PAT 2,345 2,650 2,800 2,671 2,757 + Extraordinary items - - - - - Reported PAT 2,345 2,650 2,800 2,671 2,757 Adj. FDEPS (` / sh) 3.3 3.8 4.0 3.9 4.0 Adj. FDEPS growth (%) 19.0 13.1 5.6 -2.6 3.2 Source: Company, Anand Rathi Research Fig 3 – Cash-flow statement (` m) Year-end: Mar FY15 FY16 FY17 FY18e FY19e Adjusted PAT 2,345 2,650 2,800 2,671 2,757 + Non-cash items 722 662 590 630 698 Cash profit 3,066 3,312 3,390 3,301 3,455 - Incr. / (decr.) in WC 1,312 375 -36 883 -56 Operating cash-flow 1,754 2,937 3,425 2,418 3,511 - Capex -2,063 2,237 -4,788 778 1,359 Free cash-flow 3,817 700 8,214 1,640 2,152 - Dividend - - - - - + Equity raised -2,372 717 -6,778 - - + Debt raised -1,825 -1,413 -1,014 -847 -2,460 - Investments 681 118 723 5 -451 - Misc. items - - - - - Net cash-flow -1,061 -113 -301 788 144 + Op. cash & bank bal. 1,863 802 689 388 1,175 Cl. Cash & bank bal. 802 689 388 1,175 1,320 Source: Company, Anand Rathi Research Fig 5 – Price movement Source: Bloomberg Fig 2 – Balance sheet (` m) Year-end: Mar FY15 FY16 FY17 FY18e FY19e Share capital 6,663 6,733 6,813 6,813 6,813 Reserves & surplus 14,223 17,518 13,468 16,139 18,896 Net worth 20,886 24,251 20,281 22,952 25,709 Total debt 10,116 8,775 9,224 8,377 5,918 Minority interest 16 20 12 12 12 Def. tax liab. (net) 345 272 -1,191 -1,191 -1,191 Capital employed 31,363 33,318 28,326 30,150 30,448 Net fixed assets 855 971 1,061 651 753 Intangible assets 23,669 25,128 19,660 20,219 20,778 Investments 734 852 1,574 1,579 1,128 - of which, Liquid 676 768 1,523 1,523 1,066 Working capital 5,303 5,678 5,643 6,525 6,470 Cash 802 689 388 1,175 1,320 Capital deployed 31,363 33,318 28,326 30,150 30,448 Working capital (days) 64 65 60 71 67 Book value (` / sh) 29.8 34.7 29.0 33.5 37.5 Source: Company, Anand Rathi Research Fig 4 – Ratio analysis @ `35 Year-end: Mar FY15 FY16 FY17 FY18e FY19e P/E (x) 10.3 9.1 8.6 8.9 8.6 Cash P/E (x) 7.9 7.3 7.1 7.2 6.8 EV / EBITDA (x) 9.1 8.8 9.0 8.6 6.9 EV / sales (x) 1.1 1.0 0.9 0.9 0.8 P/B (x) 1.2 1.0 1.2 1.0 0.9 RoE (%) 11.2 11.7 12.6 12.4 11.3 RoCE (%) 8.2 7.8 7.3 7.2 7.9 Dividend yield (%) - - - - - Dividend payout (%) - - - - - Net debt / equity (x) 0.4 0.3 0.4 0.2 0.1 Debtor (days) 60 61 59 58 57 Inventory (days) - - - - - Payables (days) 10 10 10 10 10 CFO:PAT % 104.9 112.9 71.0 98.8 135.9 CFO:sales % 8.2 9.4 5.7 7.9 10.7 Source: Company, Anand Rathi Research Fig 6 – Revenue Source: Company 0 10 20 30 40 50 60 Aug-13 Nov-13 Feb-14 May-14 Aug-14 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 Feb-17 May-17 Aug-17 (`) FSOL 131 128 127 130 132 124 125 126 127 128 129 130 131 132 133 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 ($m)
- 3. 8 August 2017 Firstsource Solutions – Growth sluggish; retaining a Hold Anand Rathi Research 3 Result Highlights Q1FY18 Results at a Glance Fig 8 – Quarterly result Year-end: Mar Q1 FY18 % q/q % y/y FY17 FY16 % y/y Sales ($ m) 132 1.8 0.8 515 485 6.3 Sales (` m) 8,507 (1.6) (2.8) 34,569 31,747 8.9 EBITDA (` m) 735 3.5 (27.2) 3,393 3,493 (2.9) EBITDA margin (%) 8.6 42 bps -289 bps 9.8 11.0 -119 bps EBIT (` m) 582 (3.0) (31.2) 2,803 2,831 (1.0) EBIT margin (%) 6.8 -10 bps -282 bps 8.1 8.9 -81 bps PBT (` m) 794 4.3 (13.4) 3,369 2,957 13.9 Tax (` m) (140) 24.6 (23.6) (577) (302) 90.9 Tax rate (%) (17.6) -287 bps 235 bps (17.1) (10.2) -690 bps Net Income (` m) 654 0.0 (10.9) 2,800 2,650 5.6 Source: Anand Rathi Research Fig 7 – Segment-wise results Q1 FY17 Q2 FY17 Q3 FY17 Q4 FY17 Q1 FY18 Q/Q % Y/Y % Revenues ($ m) 131 128 127 130 132 1.8 0.8 Growth Y/Y % 12.3 6.7 4.4 2.1 0.8 ‐132 bps ‐1152 bps Volume growth % 6.7 3.6 8.5 4.8 -10.7 ‐1550 bps ‐1741 bps Revenues (` m) 8,753 8,572 8,601 8,644 8,507 -1.6 -2.8 Eff. exchange rate 66.9 66.9 67.8 66.7 64.5 -3.3 -3.6 Employees (EoP) 24,148 24,910 25,992 25,871 25,013 -3.3 3.6 Revenue productivity ($ ‘000/employee) 5.4 5.1 4.9 5.0 5.3 5.3 -2.7 No. of seats 23,920 22,797 22,370 22,880 23,136 1.1 -3.3 Seat-fill factor (%) 71.8 72.1 75.0 79.0 73.0 ‐600 bps 120 bps CoR (excluding D&A) (5,817) (5,950) (5,901) (6,167) (5,942) -3.7 2.1 As % of revenue -66.5 -69.4 -68.6 -71.3 -69.8 150 bps ‐338 bps SG&A (1,926) (1,768) (1,882) (1,766) (1,830) 3.6 -5.0 As % of revenue -22 -21 -22 -20 -22 ‐108 bps 49 bps EBITDA 1,009 854 818 711 735 3.5 -27.2 EBITDA margin % 12 10 10 8 9 42 bps ‐289 bps EBIT 846 694 663 600 582 -3.0 -31.2 EBIT margins % 10 8 8 7 7 ‐10 bps ‐282 bps Other Income 201 275 267 275 320 16.6 59.0 Forex gain / loss 180 271 253 279 271 -3.1 50.5 PBT 916 861 831 761 794 4.3 -13.4 PBT margins % 10 10 10 9 9 53 bps ‐114 bps Taxes (183) (149) (134) (112) (140) 24.6 -23.6 ETR % -20 -17 -16 -15 -18 ‐287 bps 235 bps PAT 734 712 698 649 654 0.8 -10.9 PAT margin % 8 8 8 8 8 18 bps ‐69 bps Source: Anand Rathi Research
- 4. 8 August 2017 Firstsource Solutions – Growth sluggish; retaining a Hold Anand Rathi Research 4 Conference Call Takeaways Company The deal pipeline in Q1 FY18 was $300m (Q4 FY17: $375m), partly bruised by GBP movement and partly by delays in decision-making. Reduction in headcount by 858 during the quarter was due to significantly lower demand in its domestic business (telecoms is under pressure) and the seasonal impact of the healthcare business in the US. The sale of its domestic business is progressing according to plan and is expected to be complete by August. This would result in a 4,500 reduction in headcount in Q2 FY18. Management is sanguine regarding the Healthcare (36.2% of revenue) and customer-management (49.5% of revenue) businesses, and has a strong deal pipeline in both these. Business outlook The company’s FY18 revenue growth (in constant currency) would be in line with the industry growth rate of ~6-8% (excl. the sale of its domestic business). Including that, comparable growth would be ~150- 175bp lower than the earlier 6-8% growth guidance. Overall, in constant currency, management expects margins to climb considerably from Q2. On a reported basis, the margin would improve by ~50bps, driven by a turnaround in ISGN (losses to move from – $460K in Q1 to +$200K in Q2 FY18). The tax rate in FY18 would be 17-19%. The company expects to be debt-free by FY19. Notes from the last quarter’s conference calls From Q4 FY17 The company expects Q1 FY18 to be subdued and largely similar to Q4 FY17. Management expects things to be buoyant from Q2 FY18. The company’s FY18 revenue growth (in constant currency) would be in line with the industry’s ~6-8% growth rate. Rupee growth would be lower due to currency shifts. The tax rate in FY18 would be 17-20%. From Q3 FY17 Q4 FY17 revenue would reflect the benefits of the Sky deal but would also see pressure at the margin level. PAT in Q4 is expected to be flattish yoy due to further investment required and adverse currency movements. FSOL is geared to strong growth in FY18 but expects macro-economic volatility to play spoilsport if regulations prove adverse.
- 5. 8 August 2017 Firstsource Solutions – Growth sluggish; retaining a Hold Anand Rathi Research 5 Factsheet Fig 9 – Revenue Q1 FY17 Q2 FY17 Q3 FY17 Q4 FY17 Q1 FY18 Revenues ($ m) 131 128 127 130 132 Source: Company, Anand Rathi Research Fig 10 – Revenue by area (%) Q1 FY17 Q2 FY17 Q3 FY17 Q4 FY17 Q1 FY18 North America 54 55 56 55 53 UK 38 38 38 38 41 India 6 7 6 6 6 APAC (RoTW) 2 0 1 0 0 Source: Company, Anand Rathi Research Fig 11 – Revenue by vertical (%) Q1 FY17 Q2 FY17 Q3 FY17 Q4 FY17 Q1 FY18 BFSI 32 36 31 28 27 Telecoms 33 30 33 33 37 Life Sciences 35 35 36 38 36 Others 0 0 0 1 0 Source: Company, Anand Rathi Research Fig 12 – Client concentration (%) Q1 FY17 Q2 FY17 Q3 FY17 Q4 FY17 Q1 FY18 Top client 21 20 24 24 28 Top-5 clients 42 44 45 43 47 Source: Company, Anand Rathi Research Fig 13 – Revenue by delivery location (%) Q1 FY17 Q2 FY17 Q3 FY17 Q4 FY17 Q1 FY18 Offshore 21.4 20.6 22.9 21.8 20.7 Domestic 5.7 5.9 5.6 6.1 6.2 Onshore 72.8 73.5 71.5 72.1 73.1 Source: Company, Anand Rathi Research Fig 14 – Workforce spread (%) Q1 FY17 Q2 FY17 Q3 FY17 Q4 FY17 Q1 FY18 India 60 61 60 60 61 Abroad 40 39 40 40 39 Total 24,148 24,910 25,992 25,871 25,013 Source: Company, Anand Rathi Research Fig 15 – Seats Q1 FY17 Q2 FY17 Q3 FY17 Q4 FY17 Q1 FY18 Number of seats 23,920 22,797 22,370 22,880 23,136 Seat-fill factor (%) 72 72 75 79 73 Source: Company, Anand Rathi Research
- 6. 8 August 2017 Firstsource Solutions – Growth sluggish; retaining a Hold Anand Rathi Research 6 Valuations The stock trades at 8.6x FY19e EPS of `4. This, we think, is fair, given that the business is struggling to match organic industry-level growth, faces currency and macro-economic headwinds in the UK, and given our fears of the impact of automation on the business. We are giving Firstsource (a BPO company) a 25% discount to mid-sized generic IT-services companies, reflecting its weaker balance sheet, slower organic growth, and higher top client and the UK concentration. IT services companies, being higher up the value chain than BPO companies, command a higher billing rate and enjoy higher margins than BPO companies. We believe that, at this stage, automation threats may be greater for BPO companies than for IT-service companies. For Firstsource particularly, client concentration also seems high, with the top client contributing 28%, and the top-five 47%, of revenue. Our target price is based on a PE of 9x, which also reflects an EV/EBITDA of 8.6x. Fig 16 – Change in estimates FY18 FY19 New Old Chg % New Old Chg % Revenues ($ m) 520 539 (3.5) 545 571 (4.5) Revenues (` m) 33,564 35,969 (6.7) 35,156 38,104 (7.7) EBITDA (` m) 3,376 3,751 (9.8) 3,882 4,037 (3.8) EBITDA margin % 10.1 10.4 -37bps 11.0 10.6 45bps EBIT (` m) 2,747 3,174 (13.5) 3,184 3,398 (6.3) EBIT margin % 8 9 -64bps 9 9 14bps PAT (` m) 2,669 2,903 (8.1) 2,755 2,915 (5.5) Source: Anand Rathi Research Fig 17 – PE band Source: Bloomberg, Anand Rathi Research Risks Dependent on inorganic growth: The company is using acquisitions and lift-out deals to accelerate revenue growth. This, though, comes with risks associated with inorganic growth measures. Long-term risks due to automation: We reckon that the BPO sector might see slower-than-industry revenue growth on account of the impact of automation on the industry. 0 2 4 6 8 10 12 14 Aug-13 Nov-13 Feb-14 Apr-14 Jul-14 Oct-14 Dec-14 Mar-15 May-15 Aug-15 Nov-15 Jan-16 Apr-16 Jul-16 Sep-16 Dec-16 Feb-17 May-17 Aug-17 FSOL
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Important Disclosures on subject companies Rating and Target Price History (as of 8 August 2017) FSOL 9 1 2 3 4 5 6 7 8 20 25 30 35 40 45 50 55 Jan-14 Mar-14 Jun-14 Sep-14 Nov-14 Feb-15 May-15 Jul-15 Oct-15 Jan-16 Apr-16 Jun-16 Sep-16 Dec-16 Feb-17 May-17 Aug-17 Date Rating TP (`) Share Price (`) 1 28-Oct-14 Buy 59 39 2 17-Nov-14 Buy 57 40 3 09-Apr-15 Buy 47 31 4 04-Aug-15 Buy 40 32 5 13-May-16 Sell 40 40 6 28-Jul-16 Sell 44 47 7 28-Oct-16 Hold 44 39 8 31-Jan-17 Hold 42 39 9 08-May-17 Hold 40 39 Anand Rathi Ratings Definitions Analysts’ ratings and the corresponding expected returns take into account our definitions of Large Caps (>US$1bn) and Mid/Small Caps (<US$1bn) as described in the Ratings Table below: Ratings Guide (12 months) Buy Hold Sell Large Caps (>US$1bn) >15% 5-15% <5% Mid/Small Caps (<US$1bn) >25% 5-25% <5% Research Disclaimer and Disclosure inter-alia as required under Securities and Exchange Board of India (Research Analysts) Regulations, 2014 Anand Rathi Share and Stock Brokers Ltd. 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