Firstsource's focus on profitability should pay dividends

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The current financial year will be a year of consolidation for city-based business process outsourcing (BPO) company Firstsource Solutions. Its new parent, CESC, has streamlined the key focus areas for a successful turnaround of the company, which will bid adieu to non-profitable clients and improve cost efficiencies (by cost optimisation and increasing the revenue per employee). It also aims to eliminate debt (net debt of $167 million or Rs 1,020 crore) over the next four years.

"Fundamentally, this year will be devoted to consolidation of top line. There are some accounts which are not profitable. There will be rationalisation of such customers. There will be a focus on costs and margins," said Firstsource chairman Sanjiv Goenka.

Clearly, the company plans to focus on profitable growth. However, as it embarks upon client consolidation, revenue for this financial year may take a hit, leading to a flat top line growth. Management, though, remains fairly confident of showing some rise in revenues in FY15. In addition, Firstsource is also exploring inorganic opportunities in the data analytics space. Though these buyouts will be smaller in size, they will add to the BPOs offerings.

Although Firstsource is focussing on the right things, its ability to ramp up revenues and profits will be tested, given the weak macro environment. Sustainable traction in the company's financial performance could thus be a good entry point in this stock.

The Firstsource scrip had touched its one-year high of Rs 15.23 on July 17, post Rakesh Jhunjunwala bought a four per cent stake in the company. Thereafter, the stock has witnessed correction to Rs 12.18 currently, and now trades at 4.6 times FY14 estimated earnings. Going ahead, gains will be depend on the company’s successful implementation of the strategy to enhance profitability.

The company hopes to benefit from cross-selling opportunities in the health care vertical and expects that health care, along with its financial services vertical, will be the key growth drivers. The company has to repay $11 million every quarter in FY14 towards its debt. The management highlighted that they would be able to address all these payments from internal accruals and own resources. It had cash worth Rs 153 crore on its books as on June 30, 2013; it had reported a net profit of Rs 146 crore in FY13.

For the June quarter, Firstsource's sales grew one per cent to Rs 719 crore, while net profit grew 2.1 per cent to Rs 41 crore, compared with the March 2013 quarter. The earnings before interest, taxes, depreciation and amortisation (Ebitda) margin, though, contracted 50 basis points sequentially to 11.2 per cent, thanks to the wage hikes. However, the company plans to scale up its Ebitda margin to 12-12.5 per cent in FY14 as a result of its focus on improving profitability.

Meanwhile, for CESC, analysts believe the BPO will contribute meaningfully to its profits. “Firstsource is likely to deliver return on investment of 18.5 per cent to CESC, in line with the returns of the regulated power business.

Hence, it will not be RoE (return on equity) dilutive in nature. With its robust cash flows, Firstsource's debt will get serviced without any external support”, says Shankar K, power analyst at Edelweiss Securities.