Friday, February 3, 2023

Birlasoft Records Disappointing Operating Performance In Q3, 2023


CMP: Rs272  

Target Price: Rs325

Birlasoft reported a disappointing operating performance in Q3FY23 and reported performance was further exacerbated by one-off provisions. Revenue fell 0.3% QoQ to USD148.4mn (flat CC), missed expectations, due to higher-than-usual furloughs and clients putting some projects on hold. Adjusted EBITM declined 180bps QoQ due to higher furloughs, investments in capabilities, and strengthening leadership. The exact financial impact of bankruptcy filings by Invacare remains indeterminable currently. Birlasoft has made a provision of Rs1.5bn against the outstanding receivables and contract assets and is taking legal advice on the matter. Invacare revenue run rate is <3% of revenue currently. Ex-Invacare, management expects operating performance in Q4 to be better than Q3 due to planned deal ramp-ups and absence of furloughs. It aspires to return to ~15% EBITDAM soon. We have cut EPS estimates by 13-34% for FY23E-25E, factoring in Q3 performance and client-specific issue. The stock’s valuation remains undemanding; however, the stock’s performance hinges on clarity on the impact of Invacare, revenue growth acceleration, and margin recovery in the coming quarters. We maintain BUY with a TP of Rs325 at 16x Dec-24E EPS (earlier Rs380), considering reasonable valuation (>6% FCF yield) and anticipated turnaround in operating performance.

Result summary: Birlasoft’s revenue declined by 0.3% QoQ to USD148.4mn (flat CC QoQ), below our expectation of USD149.9mn. Adjusted EBITM declined by 180bps QoQ to 11.2%, ~220bps below our expectations. Reported EBITM fell ~1420bps QoQ to -1.1% on account of Rs1.5bn provision created against outstanding receivables and contract assets related to the Invacare deal. Revenue growth was led by the BFSI (5% QoQ) and lifesciences (1.3%), while E&U and manufacturing fell by 1.7% and 2.6%, respectively, due to furloughs and project holdups. Among services, business and technology transformation and cloud and base services led the growth, registering 5.6% QoQ and 1.3% QoQ growth, respectively, while enterprise solutions declined by 7.1%. Larger accounts continued to drive growth with the top-5, top-10, and top-20 customers registering 1.7%, 1.2%, and 0.4% QoQ growth, respectively, in line with the company’s strategy to focus on strategic accounts and expand relationships. The deal intake in Q3 stood at USD231mn, including net new TCV of USD102mn. What we liked: Healthy deal intake, strong cash conversion, and moderating attrition (25.5% in Q3 vs. 27.4% in Q2). What we did not like: Weak operating performance, MSA termination by Invacare, and weakness in E&U and manufacturing.

Earnings call KTAs: 1) Birlasoft has created a provision of Rs1.5bn against the outstanding receivables and contract assets related to the Invacare deal in Q3. 2) Management highlighted revenue contribution of Invacare stood at less than 3% of its revenue in Q3FY23. Management indicated the billing run rate is 2x of the revenue run rate currently. Going forward, any revenue recognition for work performed/work to be performed will be recognized on collection basis. 3) While near-term uncertainties prevail, it expects healthy IT spends by its clients with a focus on operational excellence, customer experience, and cost efficiencies. 4) The company highlighted a leadership change in its key verticals of E&U, lifesciences, manufacturing, and hi-tech. 5) Management highlighted that while its growth in the enterprise business remained weak over the last couple of quarters, it expects the segment to have a turnaround in a couple of quarters with the manufacturing cycle turning. 6) Attrition trended downwards and stood at 25.5% in Q3FY23 vs. 27.4% in Q2FY23. 7) DSO stood at 55 days.

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