The Hindu Business Line : Aztec Software: Buy

While the stock has been re-rated in the last month, appreciating by nearly Rs 10, there is potential for further capital appreciation from these price levels over the next few quarters.

Risk-averse investors may, however, stay away from this stock. The stock is now traded in the Group T (trade-for-trade settlement) category. Our recommendation is predicated on three factors:

One, the technology environment in the US is beginning to look up and the enhanced corporate IT spending is likely to be directed at segments such as security and integration software.

As Aztec's technology focus is mainly on providing product-based development services to IT enterprises and independent software vendors in these two segments, among others, it is expected to capitalise on this growing opportunity;

Two, the offshore component of product engineering and other professional services provided by Aztec is fairly high and that, in turn, will help offer greater stability and predictability to its revenue streams; and

Finally, if the technology environment remains strong, Aztec will be in a position to leverage its existing Sales, General and Administrative (SG&A) expenses to build a much higher revenue base.

As this fixed cost gets spread over a higher revenue base, it will offer a beneficial impact on its bottomline.

Robust earnings card

The strong performance of Aztec in the first quarter ended June 30, 2004 provides some pointers to revenue and post-tax earnings growth in the next few quarters.

Consider the highlights for the first quarter:

On a sequential basis, the revenues of Aztec have grown by 27 per cent to Rs. 16 crore.

Despite a drop in the blended billing rates to $19.4 (from $21 in 2003-04) and lower offshore utilisation levels, the gross margin increased by 0.5 percentage points to 39.2 per cent. The effect of a hike in salaries is also a factor.

The contribution of offshore revenues at 82 per cent (up from 77 per cent in the previous year) is significantly higher than its medium and small-sized peers.

The operating profit margin at 13.6 per cent was considerably higher was nearly 10 percentage points higher on a sequential basis.

The rise is attributed largely to the sharp drop in SG & A to 25.6 per cent of revenues from 35 per cent in the previous quarter.

The company has achieved this by shifting support activities offshore, rationalisation of expenses and repositioning of sales team.

The post-tax earnings at Rs 2.8 crore have grown over ten-fold compared to the corresponding period of the previous year and on a sequential basis.

Risks and challenges

The risks to our recommendation are:

Stability in billing rate: The average blended billing rates of Aztec have declined to $19.4 in the latest quarter.

Unless the billing rates stabilise at this level and start inching upwards, the gross margins may start coming under pressure.

Client concentration: The top five and ten clients of Aztec account for 56 per cent and 82 per cent of revenues in the latest quarter.

While this may be in line with its mid-sized peers, given its smaller revenue base, its revenues remain vulnerable to downsizing by any of its top clients either on account of economic turbulence or restructuring at the global level. Some of its existing customers are Novell, Honeywell, Cadence and IBM.

SG&A control: The key to Aztec's growth lies in its ability to increase utilisation levels and keep the SG&A under control.

As long as Aztec is able to maintain its SG&A at 25 per cent of revenues or lower, the beneficial impact of growth of revenues will flow to the bottomline.

If the competition from frontline and mid-sized companies intensifies, Aztec may be forced to step up SG&A to protect volume growth. Any sharp rise in these costs, however, can affect the per share earnings growth.

Acquisition risks: With cash and cash equivalents of Rs 73 crore in its balance-sheet in the latest quarter, Aztec has been scouting for acquisitions for sometime now.

Finding the strategic fit in acquisitions will hold the key to its future growth. It will expose the company to integration and employee retention challenges.

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Investment Quiz

Telecom majors slash tariffs

Taking stock of retail brands

Evaluation check-list

Steel prices: Tinkering with tariffs makes little sense

Ideas packaged as stocks

PruICICI Growth: Sell

Magnum Taxgain: Hold

Sundaram Select Focus

SBI Magnum declares 30pc dividend

Blue Star: Buy