iGATE Global an underperformer: Kotak

Broking house, Kotak Equity Research has maintained an underperformer rating on iGATE Global Solutions with a target of Rs 325.

Kotak Equity Research report on iGATE Global Solutions

• Revenue growth below expectations    
• Margins target for 4QFY07 met; margins will likely be under pressure in    1QFY08   
• Revenue growth likely to be sluggish in 1QFY07   
• Revising FY2008 and FY2009 EPS estimates downwards by 6.4% and 12.3% to Rs 22.5 and Rs 30 respectively. Maintain Underperform with a target price of Rs 325 per  share. 

iGate’s reported net income of Rs226 mn for 4QFY07 was 12.3% ahead of our estimates, led by a) aggressive rationalization of costs leading to absolute decline in both direct and SG&A expenses b) lower than expected depreciation costs and c) lower than expected tax rates. Operating margins expanded 260bps to 15.3% to surpass management’s target of 15% for the quarter. While the operating margin performance is impressive, the critical factor for P/E re-rating and sustained stock performance, in our view, is acceleration in revenue growth rates to tier-I levels, which will likely be a challenge for iGate in the near to medium term. Revenue growth in the Mar ’07 quarter was a disappointing 2% qoq in US$ terms, impacted by specific challenges in the iTOPS business. In addition, new customer addition continues to be below our and management expectations. We are revising our EPS estimates for FY2008 and FY2009 downwards by 6.4% and 12.3% to Rs 22.5 and Rs30 respectively. Maintain Underperform rating with a target price of Rs 325 per share.    

Client acquisition pace critical for acceleration in revenue growth:

We believe that the most critical factor for sustained stock performance of iGate is acceleration in revenue growth rates, which is contingent on two factors—a) new client acquisition, which has been slower than the management’s stated target of 8-10 new customers each quarters—it added 6 new clients in Mar ’07 quarter and 25 in FY2007 b) ramp up from existing clients—conversion of new account wins to sustained revenue billing is again below expectations. We expect iGate to once again trail industry revenue growth for FY2008.   

4QFY07 revenue growth disappoints; will likely remain sluggish in Jun ’07 quarter.

iGate reported modest revenue growth of 2% qoq (US$ terms). Revenue growth was primarily impacted by slowdown in revenues from clients in the subprime mortgage segment (9% of iGate’s 4QFY07 revenues) in the US. We note that 2 out of iGate’s top 20 clients are from this segment. Companies in the sub-prime mortgage segment in the US are grappling with pressures from rising default rates and borrowing costs. iGate’s business with these clients is largely transaction-based and thus, any slowdown in loan origination and servicing transactions from these clients has an immediate negative impact on revenues. Management indicates that revenues from this segment will further decline in the Jun ’07 quarter and expects revenue growth to remain sluggish in the quarter.