Hexaware Technologies: Buy

Many mid-tier IT companies have a made a strong comeback after a rather challenging period from 2008-10, by strengthening focus on key verticals, winning many new and large deals and improving operational parameters.

Hexaware Technologies is one such player to witness a significant revival in fortunes. The company has managed to win large deals, make significant customer additions and derive greater traction in its high-margin enterprise solutions offering. Investors with a two-year horizon can buy the shares of the company as it appears to be on a steady growth path and may also be able to enhance margins.

At Rs 123, the share trades at 11 times its likely per share earning for CY12. This valuation multiple is at par with MindTree, thus making it a reasonable buying opportunity.

In CY11, the company’s revenues rose by around 38 per cent over the previous year to Rs 1,451 crore, while net profits zoomed 148 per cent to Rs 267 crore.

The growth momentum has sustained through the current fiscal as well. Revenues rose around 44 per cent in the first half of CY12 over the same period last year to Rs 938.4 crore. Net profits increased 55.5 per cent to Rs 177.4 crore. Hexaware’s operating margin (EBITDA) of around 25 per cent is among the highest in the mid-tier IT space. In fact, it compares favourably with most large software players.

Key segments grow

The company has been able to derive significant growth in enterprise solutions services (mainly Peoplesoft). This high-margin offering has grown at the pace of the company’s revenue rate or even exceeded it over the past several quarters.

This service now accounts for almost a third of the company’s revenues. Oracle Corporation, which owns the Peoplesoft product and of which Hexaware is a leading implementation partner, has delivered results much higher than market expectations over the past few quarters. Specifically, there has been robust increase in licence revenues from software products for Oracle. This means that players such as Hexaware would be able to benefit from the trend and derive significant annuity revenues.

Also, its traditional application development and maintenance services (38.3 per cent of revenues) have been growing at a steady pace. Overall, its service-mix looks well balanced with resilient and high-margin offerings.

Hexaware’s key verticals such as BFSI and Healthcare too are expanding significantly. Only the travel and transport segment has been rather weak as the airlines sector is yet to recover fully from the global economic slowdown.

The company has also not been affected by the European slowdown. The region has, in fact, increased its contribution steadily to revenues from 27.2 per cent to 29.2 per cent currently. Though revenues from the US, its largest geography, have slowed down a bit, it is being compensated by expansion in the Asia-Pacific region.

Strong deal pipeline

The company has managed to sign up large deals with a fair degree of consistency over the past 12-18 months. After the $177-million contract announced last year with an existing client, Hexaware has recently signed up a $100-million deal spread over four years.

These deals have also helped the company climb up the value chain by executing multiple services across geographies.

Over the last one year, the number of clients with sizes of over $20 million, $10-20 million and $5-10 million have increased by one each. Additions in the other smaller categories have been healthier.

Apart from winning new projects, the company has also been able to mine its existing clientele quite well. This is attested by the fact that revenue contribution from Hexaware’s top clients has held steady and its repeat business is a healthy 93.2 per cent.

Billing rates too have seen marginal increases, suggesting that there have been no significant discounts offered on large contracts.

The offshore component of revenues has risen steadily over the past one year from 43.3 per cent to 46.6 per cent currently. This shift of project execution to offshore locations significantly optimises costs.

Attrition has fallen significantly in the last 12-18 months and is at 9.6 per cent currently, which is among the lowest in the industry.

Although billing rates have held steady, increasing competition in the space from peers may strain realisations in future.

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