Persistent Systems upgraded to ‘buy’
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We raise Persistent Systems' rating to buy from underperform as its high offshore leverage should make it a key beneficiary of industry-wide lower wage hikes in FY13 and a weak rupee. While revenue predictability is still low, the company is likely to grow ahead of the industry, given improving traction in its IP business and stabilised outlook for two of its top 10 accounts that were on a decline.
At 7.8x FY13E EPS, valuation looks attractive in the context of a 28% EPS growth in FY13e against other mid-tier peers. Persistent Systems' EPS CAGR over FY12-14E is comparable with the other buy-rated peer, Hexaware. Persistent Systems trades at ~28% discount to Hexaware currently.
Our price objective of R460 is based on 10x FY14E EPS — higher than our previous PE multiple of 7.5x. We believe that this higher multiple is justified, given a stabilised demand outlook against six months back and higher operating profitability of the business. Our target multiple for FY13 implies a 15% discount versus other mid-tier vendors like Hexaware, which, in our view, is fair, given Persistent Systems' higher exposure to discretionary IT spends.
We expect offshore wage hikes at Persistent Systems at ~10% for FY13e against 15-17% last year, on lower industry-wide wage hikes and benign attrition rate. This should help Persistent Systems maintain flat operating margin for the year with the impact of wage hike being offset by a 300-500 bps jump in utilisation rates and 2-3% higher billing rate. Higher contribution of IP revenues is a key lever for FY14.
Given that the company has high offshore leverage (80% of revenues against 50-60% for most peers), it is likely to see a higher benefit from rupee depreciation. We estimate 1% depreciation of the rupee would boost EPS by ~2%, on a post-hedge basis (we assume USD-INR 53 for FY13e). It tends to get impacted the most in years with high offshore wage inflation. Offshore wage bill is nearly 35% of the top line for Persistent Systems against ~20-25% for other vendors.
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