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  • Stock Recommendation | ZENSAR TECHNOLOGIES LTD – ACCUMULATE – Target Price : 257

    Publish date: OCTOBER 25, 2018

    Zensar’s 2Q revenue grew by 2.3% QoQ in USD terms to USD 138mn (de growth of 0.7% sequentially without Indigo Slate), marginally below our estimate of USD 139mn. The lower growth can be attributed to lower than expected organic growth. EBITDA margins shrank by ~70bps QoQ to 12.9% primarily because of wage hikes and lower utilization which was offset by lower SG&A expenses.

    Digital which has been the key focus area for the company showed a slow down in growth rate of 4.1% v/s 6.6% in previous quarter. The slow down in growth rate within the digital was primarily due to lower growth of Digital Services (7% v/s 13.5% in previous quarter) whereas Core Application Services growth remained similar to previous quarter. Growth within Cloud and Infrastructure Services too slowed down to 4.2% v/s 13% in previous quarter. Digital now contributes 44% of the overall revenue.

    Company booked deals in north of USD 600mn in last 12 months of which several USD 20mn+ deals were booked. Cloud Infra alone has won total deals worth USD 45mn+ in previous few months. Digital deal sizes are increasing and the overall deal pipeline remains healthy for the company at USD 800mn+ TCV. Booking stood at USD 290mn+ during first half including more than USD120mn in 2QFY19. Company is working with advisors and has a differentiated strategy of platform plus services which is helping in gaining traction and company being invited for more RFPs.

    Zensar has been aggressively consolidating its non core verticals and service lines. Company now focus on strategic accounts which have a capability to scale up digital. Digital deal sizes are small currently, new deal wins are from area of digital which indicates good progress towards adoption of digital.

    Zensar acquired four companies in the last two years. Keystone, Fullproof, Cynosure are fully integrated and the latest Indigo Slate is expected to be integrated by next quarter. New and existing engagements are both contributing to the revenue growth. The acquisitions have also been an integral part of new deal wins.

    At current price of Rs.236, stock is trading at 15.3x/12.9x P/E on FY19/FY20 estimates. We maintain our estimates for FY19-20E and will wait for Retail vertical to stabilize as we believe digital plays a pivotal role more so in retail vertical than any other vertical and as digital remains a key focus area for the company. We maintain ACCUMULATE with a revised target price of Rs.257 (Rs.274 earlier).

    Zensar reported revenues of USD 138m marginally below our estimate of USD 139m due to lower than expected organic growth. Without integration of Indigo Slate, revenues declined 0.7% sequentially largely due to Retail segment which saw some project closures earlier than expected. EBITDA margins at 12.9% was ahead of our estimates of 12.5%. In our view, the beat was due to positive impact of INR depreciation, better business mix (higher revenue contribution from digital) and lower SG&A expenses which offset the wage hikes and lower utilization during the quarter. We believe margin improvement from here on would be a function of growth in revenue as utilization has been maxed out as highlighted by us earlier. Retail which contributes about 22% of the revenue saw a sharp decline of 8.7% sequentially. Management believes this is a bottom for the Retail business especially in US which was worst impacted during the quarter. It is expected to do better in 2HY19.MVS business is expected to remain flattish in the range of USD10-15mn as the management doesn’t intent to invest any further in this business. Post the leadership change company has launched many new solutions/services which has helped in reviving revenue growth trajectory. It now focus on large deals which is visible in improving deal wins and steady TCV wins. Company added 6 client in USD 1mn+ and 2 client in USD 10m+ bracket taking the total client count to 325. Company is seeing good traction in cloud migration projects within the IMS segment. Management continues to focus on Retail, Insurance, Hi tech and manufacturing vertical, investments too are being made in these verticals only.

    Revenues from Digital formed 44% of 2QFY19 revenues v/s 43% in previous quarter leading to a sequential growth of 7% in CC Terms. Within Digital, Zensar is focused on the following areas - e-commerce, customer experience, analytics, digital marketing, cloud, cyber security and IoT. Company has built about 30 platforms for its Return on Digital strategy. Company would continue its investment in Digital through acquisition. Management guided that it is currently selling atleast one Digital service to ~60 clients. It has strengthened its Digital practice with acquisitions. Management would also focus on setting up Digital center in USA. However, we believe the Digital space remains competitive and it would be challenging to maintain growth unless the offerings are a key differentiator from the rest.

    Company availed loan of about USD 18.9mn during the quarter for acquisition of Indigo Slate.

    Europe and Africa continue to do well in spite of some headwind faced by them in dollar terms. Europe grew by 10.9% and Africa grew by 5.6% sequentially in CC Terms.

    Subcontracting cost was higher as large deals won had some sub contractors already working on the deal. Higher onsite was due to acquisition of Indigo Slate and Cynosure. Going ahead subcontracting should go down while onsite should stabilize.

    Out of the new deals won Ruffers is in the transition phase whereas City of San Diego deal is in steady state. San Diego is around network security whereas Ruffer is a whole stake deal.

    Retail vertical saw some project ramp down as large part of Retail business is project business. The ramp down happened sooner than expected, however there are enough closers done and won’t affect 3Q revenues.

    Total hedge stands at USD 110.9mn v/s USD 116.3mn in previous quarter. DSO stood at 67 days v/s 71 days in previous quarter.

    Depreciation to remain higher as it includes amortization of acquired intangible assets.

    Tax rate is expected to be in range of 28-29% for FY19.

    Zensar is a leading digital solutions and technology services company that specifies in partnership with global organizations across industries on their Digital Transformation journey. The company has complete technology services portfolio which includes Applications, Infrastructure, Digital and Industry specific solutions lineage. Zensar is a part of the USD $3bn RPG Enterprises and the US $40bn APAX portfolio of companies. Digital business is 34% of Zensar revenue and has shown strong growth.

    BUY - We expect the stock to deliver more than 12% returns over the next 12 months
    ACCUMULATE - We expect the stock to deliver 5% - 12% returns over the next 12 months
    REDUCE - We expect the stock to deliver 0% - 5% returns over the next 12 months
    SELL - We expect the stock to deliver negative returns over the next 12 months
    NR - Not Rated. Kotak Securities is not assigning any rating or price target to the stock. The report has been prepared for information purposes only.
    SUBSCRIBE - We advise investor to subscribe to the IPO.
    RS - Rating Suspended. Kotak Securities has suspended the investment rating and price target for this stock, either because there is not a Sufficient fundamental basis for determining, or there are legal, regulatory or policy constraints around publishing, an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon.
    NA - Not Available or Not Applicable. The information is not available for display or is not applicable
    NM - Not Meaningful. The information is not meaningful and is therefore excluded.
    NOTE - Our target prices are with a 12-month perspective. Returns stated in the rating scale are our internal benchmark.

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