eClerx Services: Buy

Despite a challenging economic outlook for many developed economies, a few small-to-mid-sized IT/BPO/KPO players continue to thrive, due to growth in outsourcing.

eClerx Services is one such BPO and KPO player that has continued to penetrate deeper into its two key segments of operation — financial services and e-commerce companies.

Sustained growth in the contribution of its top clients, increasing utilisation rates and improving realisations are key positives for the company.

At Rs 718, the share trades at 10 times its likely FY13 per share earnings, making it a reasonable bet for investors with a two-year horizon.

Cash per share of Rs 68.7 provides added comfort to valuations.

From an industry perspective, the relatively non-discretionary nature of BPO/KPO services means that companies such as eClerx that cater to this segment remain less susceptible to change in technology spends. Such services are directly related to cost-cutting in customer organisations and help maintain business efficiency. Again, retail and especially e-retail has been a strongly growing vertical for many of the large software players such as Infosys and TCS. This business continues to grow at a healthy pace in both in the US and Europe. eClerx thus operates in segments where there are substantial outsourcing opportunities.

In the first nine months of this fiscal, the company's revenues rose 40 per cent over the same period in FY11 to Rs 345.3 crore, while net profits increased by 39.2 per cent to Rs 129.4 crore. This follows an impressive run in FY11 as well, suggesting that the company has been able to tap significant opportunities after the turbulent phase witnessed in 2008-09.

Key segments improve

eClerx has seen its top five clients increase contributions steadily from 2009; they now account for 86 per cent of its overall revenues. This indicates that the company has been able to mine its existing large-clients strongly and scale them significantly.

Despite the scenario, where large customers around the world have reduced the number of vendors that they have been working with, the company has been a net beneficiary of this process of rationalisation.

Many small offshore vendors were taken off the radar. But that eClerx has bucked this trend suggests reasonable execution capabilities. In the recent quarters, the company's top five clients as well as the other customers have been growing at a similar pace to that of the overall company's.

As the other(non top five) clients scale up, albeit from a low base, it would ensure that the overall growth remains intact even if a couple of large customers delay or slowdown the process of giving out new projects. eClerx added eight new clients in FY12, taking its base to 53. Although such heavy client concentration may pose a risk, it is generally not uncommon for small to mid-sized company to have such a lopsided customer run-rate.

Also, since the company has been able to penetrate deeper into its large customer accounts revenue concentration may not be a worrisome aspect. In fact, due to this strategy, the selling and distribution costs for the company have been stable at 11-12 per cent of revenues over the past several quarters.

Business positives

eClerx has been able to increase its utilisation rates significantly. From mid-60 per cent levels in 2009-10, the company has been able to increase utilisation to 72 per cent now.

This suggests that volume (man-hours billed) growth has been significant for the company. There has also been a 2.5-3 per cent increase in billing rates over the past one year for the company. This compares favourably over most mid-tier IT companies and even some large software players.

These should help the company maintain and expand margins.

eClerx has also increased its billing mix with the proportion of full-time equivalents (FTE) increasing 20 percentage points a couple of years back to 94 per cent currently. This means that the company would have steadier billing and sustainable annuity revenues.

It also has a healthy geographic-mix, with the US contributing 70 per cent of revenues and Europe about 24 per cent. This makes for a healthy blend.

The US revenue has grown faster in recent quarters, due partly to a stronger dollar.

Attrition, though on a declining trend, is still quite high at 26 per cent for the company. Any wage hikes to stem this phenomenon in the event of a job market turnaround may affect margins.

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