Firstsource Solutions rally to speed up

Easing of client-specific issues, strong revenue visibility, and debt repayment are key catalysts

The key factors that hindered the performance of business process outsourcing (BPO) Firstsource Solutions Ltd (FSL) have largely been resolved.

Firstsource had faced pressures in FY15 on account of client-specific issues and debt. Its share price nearly halved between December 2014 and October 2015. The company had restructured its client portfolio, triggering revenue volatility. With markets realising that these issues are behind, the stock has surged 63 per cent in about three months.

Domestic brokerages such as Sharekhan and Religare Capital Markets have recently raised their earnings estimates, as well as price targets. Analysts say stability among top clients and improved revenue momentum in key verticals such as health-care, telecommunications, media and BFSI (banking, financial services, and insurance) will drive growth. The management is also looking out for strategic acquisitions and is confident on delivering a better performance in the second half of FY16.

The management believes the cash generation, too, will improve in the second half of the financial year and expects to be net cash-positive by March 2017. The company had net debt of $105 million (about Rs 700 crore) at the September quarter-end.

Analysts at ICICI Securities expect the company to repay debt worth $22.5 million in the second half of FY16 and reduce the net debt to $82 million. The operating margins are likely to improve, though marginally, by 50-60 basis points in the next two years.

Improving profitability and scale will lead to better return ratios, a key valuation indicator. Firstsource’s return ratios (return on capital employed and return on equity) have more than doubled between FY12 and FY15 and this trend is likely to continue, aided by repayment of debt by FY17. The key downside risk, however, is high attrition. Any meaningful spike in this metric or in the foreign exchange could hurt. Likewise, a resurgence of client-specific issues needs to be watched.

On average, analysts  expect the stock to deliver 19 per cent from current levels. All brokerages polled by Bloomberg since October have a ‘buy’. Analysts at Religare believe the stock is trading at cheap valuations and consistent execution and improving returns on equity ratio should lead to a re-rating.