The Hindu Business Line : Hexaware Technologies: Hold

Hexaware expects to double its revenues and post-tax earnings in the next eight-10 quarters. Our cautious short-run view, however, stems from Hexaware's muted first quarter post-tax earnings guidance.

Mr Atul Nishar (Right), Chairman, and Mr Rusi Brij, CEO and Vice-Chairman.

Investors with a high-risk appetite can retain their exposure in the Hexaware Technologies (Hexaware) stock with a one-year perspective. At the current market price, the stock trades at a price-earnings multiple of 18 times its calendar 2006 per share earnings. Since our last recommendation on October 15 at Rs 165 (before the July-September earnings announcement), the stock had perked up marginally to Rs 175, yet under-performing the broad market. The returns from the stock are likely to be sedate and accrue over a longer time-frame.

We remain positive on the long-term prospects of Hexaware. The management has reiterated that it can double its revenues and post-tax earnings within the next eight-10 quarters. Second, the FocusFrame acquisition that Hexaware made in the area of automated testing in November in an all-cash deal for $34.3 million is expected to accelerate its testing practice significantly. The management has indicated that the company's overall testing practice revenues can grow nearly three-fold to $100 million within the next three years. Finally, Hexaware started calendar 2007 with an order book of $170 million, with 129 active clients, including 41 Fortune 500/Global 500 corporations.

Hexaware's core business model is its positioning as a niche software services provider of Peoplesoft suite specialising in the Human Resource Services domain. This is apart from addressing airlines/transportation vertical and German geography. The core model has since been broad-based to include SAP and Oracle-related services in package implementation and an expanded focus into other European markets beyond Germany. For calendar 2006, while enterprise packages (including HR) contributed 41 per cent of revenues, Europe accounted for 25.8 per cent.

Our somewhat cautious short-run view, however, stems from Hexaware's muted post-tax earnings guidance (revenues are expected to be strong) for the January-March quarter of 2007 and the integration of its FocusFrame acquisition. In the latest October-December quarter too, the earnings numbers were disappointing primarily on account of the sharp appreciation in the value of the rupee by 3.6 per cent. While the revenues of Hexaware grew by 6.8 per cent on a sequential basis ahead of guidance, the post-tax earnings registered a negative sequential growth.

Examining Hexaware's latest quarter's performance vis-à-vis the periods reflects the following:

In the fourth quarter of 2006, the contribution of offshore revenues slipped to 38.4 per cent from 38.9 per cent in the third quarter. Since the offshore mix has slipped for the second successive quarter, it has impacted the operating profit margin.

Through better control over direct costs, Hexaware has managed to improve its gross margin by 0.5 percentage point on a sequential basis. But a step up in selling, general and administrative expenses to 22.6 per cent (from 21.2 per cent in the previous quarter) contributed to lower operating profit margins.

Among verticals, airlines/transportation turned in a fairly muted growth in the October-December quarter, while in service offerings, growth in application management revenues was somewhat sluggish on a relative basis.

The client addition in the October-December quarter has also been sluggish. This was only to be expected as the company had added nine clients (from 31 in the Jan-March quarter to 40 in July-September quarter) in the first three quarters of 2006 in $1 million bracket.

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