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Spark Capital: eClerx 4QFY14 result review: Strong margin headwinds ahead, Retain SELL




Spark Capital Advisors(India) Private Limited


21 May 2014





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eClerx 4QFY14 result review: Strong margin headwinds ahead, Retain SELL eClerx reported 4QFY14 results with lower than expected US$ revenues growth of -0.4% qoq vs. 2.5% qoq growth estimate led by revenue advancement, sluggish growth in one S&M client and delay in ramp ups of cable business. Operating margins improved 231 bps qoq led by reversal of bonus provisions. Top 5 clients declined 1.9% qoq, while emerging clients improved 3.3% qoq. For FY14, US$ revenues grew 13.8% yoy to US$ 138.3 mn, with 1% incrementally contributed by Agilyst. Top 5 client concentration has declined from 78% in 4QFY13 to 73% in 4QFY14. Though it is heartening to see decline in client concentration, Top 5 clients still contribute around th of the total business and has been on a tepid quarterly run rate of 1% for FY14 compared to 8% quarterly run rate 3 years back. Management commentary suggests that top 5 client growth would continue to be tepid, while emerging vertical growth would be sluggish in the medium term with M&A activity in the U.S. cable vertical. Additionally with margins highly aided by depreciating rupee in the last two years, we believe going ahead, increased wage costs and rupee appreciation would lead to steep fall in the EBIT margins in FY15E and FY16E. At CMP, trading at higher than tier-1 average on FY15E EV/Sales, we believe risk reward continues to be highly unfavourable. Thus, we maintain our SELL rating on ECLX retaining target price of Rs.900, arrived by attaching 10x to our Mar-16 EPS. CC revenue decline of 0.6% qoq: US$ revenues declined 0.4% qoq led by decline in Top 5 client (1.9% qoq). Across geography, revenues from Europe grew 4.2% qoq while US and ROW declined 0.6% qoq and 20.4% qoq respectively. Onsite headcount increased by 2 to 74 while the overall headcount increased by 216. The company added 2 new clients this quarter. eClerx paid a final dividend of Rs.35/share. EBIT Margins improved 231 bps qoq: EBIT margins improved 231 bps qoq led by bonus provision reversals. For FY15E,eClerx announced wage hikes of 11% effective April and also made changes to the compensation structure to its onsite sales team. Cumulative EBIT margin headwinds at CC in FY15E would be around 200-250 bps. We are modeling margins to decline around 270 bps to 35.5% for FY15E. Retain SELL: Historically, strong US$ revenue growth, higher EBITDA margins (at constant currency) & healthy cash generation were prime reasons for eClerx premium P/E multiple over other mid cap peers. With strong margin headwinds ahead coupled with high valuations, we believe risk reward is highly unfavourable. Retain SELL with TP of Rs. 900.

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