Firstsource Solutions: Turnaround gets delayed on client issues

Earnings estimates cut as revenues in Q2 disappoint; company expects top line to grow 7-8% in FY16

The business process outsourcing sector has been facing headwinds over recent years. The industry was faced with rising competitive intensity, on one hand, and pricing pressures on the other. Firstsource Solutions has been battling with these headwinds in the past couple of years and the ill-timed acquisition of Med Assist at $330 million in 2007. The company has been trying for a turnaround over the past two years, as revenues and margins fell to eight per cent and Ebit margin fell to four per cent in FY12. Anand Rathi, which has the stock among its high conviction ideas, believes with the interest-cost burden lightening because of debt repayments, and focus shifting to accelerating growth, return ratios could improve. However, after the September quarter numbers, analysts have cut the company's earnings estimates as the turnaround is expected to be delayed.

Over the past two years, the company has been trying hard to go up the value chain by going beyond the low cost offerings. The company's revenue growth expected to gain momentum as the company concentrated on growing revenues and improving profitability by weeding out low cost contracts and undertaking price increases. The elevation of Rajesh Subramaniam — who was part of the founding team — as CEO and acquisition of majority stake by the Sanjeev Goenka group were seen as big positives.

In the September quarter, Firstsource reported a sequential revenue growth of 2.4 per cent but a year-on-year decline of 2.1 per cent to Rs 774 crore. Analysts claim this is below estimates as a large client walked away. Along with disappointing revenue growth, Ebit margins too were below estimates at 10 per cent and remained flat q-o-q sequentially. Emkay Global has cut its FY15/16 earnings per share estimates by eight to 10 per cent to Rs 3.6/4.7, respectively, as the brokerage is factoring in lower revenue growth and operating margin assumptions for both years.

The company has won deals worth $45 million in the September quarter, up from $36 million signed in the June quarter. Revenue from top clients also grew at a healthy pace of 4.8 per cent quarter on quarter, while revenues from the top five clients declined marginally. With the large telecom client walking away, analysts have cut their forecasts for the current year. However, a strong deal pipeline will ensure better growth for the company in FY16. The company has indicated that it expects growth to pick up pace in FY16. Sharekhan says the company has  indicated that the topline would grow seven-eight per cent y-o-y in FY16, even as growth in FY15 would be impacted by vendor consolidation and client ramp downs.

Though the turnaround has been delayed, analysts believe that the growth in the coming years would be better than the last few years, as the company has strong capabilities in the telecom and healthcare vertical. Also, the company is looking at launching product platforms, which would improve revenue potential of the company. According to Sharekhan, which has a buy on the stock, the stock trades at a reasonable valuation of 8.2x FY15 and FY16E earnings estimates.