According to Keynote Capitals Research, Firstsource Solutions is a value buy at current levels, with a long term perspective.
Keynote Capitals Research's report on Firstsource Solutions:
Firstsource Solutions Ltd. (FSL) is a third party BPO service provider in the verticals of BFSI, telecommunications & media and healthcare, in the US, European and Asia-Pacific regions.
While the company operates in the low margin BPO space, we have a positive view on the company due to factors including (i) management pedigree (promoted by ICICI) (ii) sustainable business model (ii) well-established track record in managing overseas acquisitions (iv) reducing contribution from the BFSI segment, impacted by the ongoing financial turmoil.
The company's revenues and earnings grew at CAGR of 53.8% and 127.3% respectively over FY06-08. It has a good track record of inorganic growth as well.
FSL is vulnerable to the slowdown in the US economy and exchange rate fluctuations as 62% of its revenues is attributable to the US. In our view, overdependence on the US is a major risk.
High proportion of onshore revenues (58%) is a negative. We perceive the high proportion of onshore revenues and personnel as a risk, in terms of lower margins.
However, substantial reduction in exposure to the BFSI segment (the worst affected in the ongoing turmoil in the US financial markets) is a major positive. Contribution of BFSI segment reduced from 37.1% in Q1FY08 to 27.7% in Q1FY09. However, even such exposure to the US financial segment may be considered a risk in view of the problems in the US.
The company reported 8.5% Q-o-Q revenue growth in Q1FY09 and a net loss of Rs50Cr. EBITDA margin declined from 16.6% in Q4FY08 to 14.8% in Q1FY09, due to a decline in grant income, seasonality factors and cost of work on Airtel contract, for which revenues are yet to be realised. However, the MTM loss of Rs80Cr on FCCBs is the reason behind the net loss.
The pricing for contracts is generally based on the target margin levels, which ensures higher sustainability of margins. However this pricing strategy may also lead to risks associated with currency fluctuations and the more than expected increase in staff costs.
Goodwill of Rs1888Cr ($408mn) is reflected on the balance sheet, as a result of the three acquisitions. We believe goodwill can be a contentious issue; goodwill not written off may translate into a charge in future, impairing profitability going forward. We note that ROE increased from 8.7% in FY07 to 17.3% in FY08, mainly due to write off of Rs434Cr premium payable on redemption on FCCBs.
The stock trades at 24x FY09E and 9.5x FY10E EPS. We believe the stock is a value buy at current levels, with a long term perspective.
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