Motilal Oswal red-flags Zensar’s bleak prospects; downgrades it to 'neutral'

The company was overstaffed from the earlier rounds of hiring in FY22 leading to a muted headcount addition in FY23

Brokerage firm Motilal Oswal Financial Services Ltd (MOFSL) has downgraded Zensar Technologies Ltd to 'neutral' from 'buy' as it sees global recessionary fears denting growth in FY24. The target price for the stock is Rs 390. "We expect profitability to stabilise at current levels. The peak EBITDA margin estimate of 15 percent limits near-term earnings drivers and should result in earnings growth to mirror the weak top-line performance, going forward," MOFSL's report stated.

"The near-term catalysts are already priced into the stock and it is trading at full valuation, leaving little room for a further upside. Hence, we are downgrading the stock," analysts of the brokerage explained in the report.

Moreover, the firm also forecasts a muted year-on-year (YoY) revenue growth for Zensar, dragged by an elevated sensitivity to macro headwinds in a large part of its industry mix.

Macro conditions denting growth

Zensar has been struggling with multiple headwinds in recent years, which saw it sharply underperform its peers. The company's compound annual growth rate (CAGR) grew 4.8 percent, missing the industry average by about 170 basis points. While the company is set to achieve an 8 percent CAGR by FY25, Motilal Oswal highlights that even that growth rate is among the lowest in their coverage of IT services.

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In addition, the company was one of the worst-affected by the constrained supply-side environment in FY22. The company registered a loss of 600 basis points, as it rightsized its hiring engine and fulfilled demand at a high cost. The brokerage believes profitability for Zensar will stabilise at the current levels, affecting its near-term earnings.

Persisting headwinds

The company's hi-tech, manufacturing, and consumer clients have posed ongoing challenges, leading to the dilution of the overall consolidated CAGR over FY18-FY23. MOFSL has also added that the outlook of the clients is a blur due to adverse macros, and the management doesn't expect clients from these sectors to contribute to its FY24 revenue target.

Nuvama Institutional Equities also highlighted that some factors like high client concentration, high exposure to the South African Rand, supply-side issues, and the economic instability in the US may pose a risk to Zensar's growth.

Margin touches ceiling

While MOFSL did applaud Zensar's ability to improve margins in the last two quarters by improving metrics, such as utilisation and subcontractor costs, it doesn't expect margins to improve any further, as those efforts have been maximised.

Nuvama also agrees as it believes most of the low-hanging fruits have already been plucked. The firm refers to record-high offshoring, and implementation of pyramid rationalisation as these low-hanging fruits.

Given the company's limited capabilities in winning cost takeout deals, growth in the current market conditions shall remain limited, analysts tracking the sector said.

Zensar is a mid-sized IT services company and part of the RPG Enterprise Group, an industrial conglomerate with a presence across diverse businesses ranging from tyres to life sciences. RPG Group owns 49 percent of Zensar.

At 1:00 pm on June 16, 2023, the stock was quoting at Rs 392, down 0.43 percent from the previous day's close on the National Stock Exchange (NSE).

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