Downside risk in Persistent Systems remains despite price correction

Due to several headwinds, brokerages have reduced their earnings per share estimates for FY25 by 5-8%

The stock of Persistent Systems is down 10 per cent over the last two trading sessions, as weaker than expected margin performance in Q4, moderation in order wins, delayed recovery in profitability coupled with stiff valuations hit investor sentiment.

Given the multiple headwinds, brokerages have cut their earnings per share estimates for FY25 by 5-8 per cent.

The key worry for the Street is the muted margin performance in Q4 and the delay in margin trajectory going ahead. The company posted profit margins of 14.5 per cent which was flat on a sequential basis and missed brokerage estimates which had pegged it closer to 15 per cent.

Margins were impacted by one-time transition costs due to onsite ramp-up using subcontractors, lower utilisation on account of lateral hiring for ramp-up and higher travel expenses. The combined impact of these is pegged at 200 basis points. The impact would have been higher (both in Q4 and for FY24) had it not been for the reversal of acquisition-related earn-outs.

The key margin lever for the company includes improving utilisation and offshoring which have come down by 220 basis points in the past two quarters given the ramp-up in large deals.

Downside risks

Most brokerages believe that there is a downside risk to the company’s flat margin guidance for FY25 and 200-300 basis points improvement in this metric over the next three years. Girish Pai and Suket Kothari of Nirmal Bang Research believe that achieving 200-300 basis points margin improvement will be challenging as delivering industry-leading revenue growth (which is likely PSL’s bigger priority) would require it to fight for managed services contracts with Tier-I players.

This would require the company to make extra investments in sales and marketing, higher onsite employees initially, solutioning, hiring subcontractors, rebadging of employees, taking on third-party items like software and hardware onto the profit and loss account and possibly lower pricing.

Brokerage Kotak Research believes that the prioritisation of investments in sales, capability and large deals will slow down the margin improvement trajectory. Analysts led by Kawaljeet Saluja have cut their FY26 margins by 80-100 basis points, leading to a 6-8 per cent cut in FY26 earnings per share.

Even as the operating performance in Q4 and the margin outlook disappointed the Street, the revenue performance was healthy. The company posted a 3.4 per cent growth Q-o-Q on a constant currency basis and this was in line with brokerage estimates. Growth in the quarter was led by a ramp of large deals in the healthcare and BFSI verticals. While growth in the quarter was healthy, it was lopsided with healthcare and life sciences (24 per cent of revenues) accounting for 94 per cent of incremental growth.

Slowing deal wins

Moderating deal wins is another concern which, coupled with challenging macros, could weigh on growth. Total contract value (TCV) came in at $447.9 million, which was down 14 per cent on a sequential basis and up 6 per cent Y-o-Y. FY24 TCV growth decelerated from 33 per cent in FY23 to 13 per cent in FY24.

Annual contract value growth at 11 per cent trailed TCV growth, reflecting soft discretionary spends, points out JM Financial Research. The brokerage has cut its earnings per share by 3-7 per cent for FY25/26. A steep 10 per cent correction in the stock post-result reflects potential earnings downgrades, but also ills of rich valuations, said Abhishek Kumar and Anuj Kotewar of the brokerage.

Other brokerages also point out that valuations of the software service provider remain rich despite the correction in the stock price post results. While Persistent could be among the top quartile performers in FY25 in terms of revenue and earnings growth, the current valuation of 42 times FY25 earnings estimates is excessive, said Nirmal Bang Research.

The brokerage has reiterated its ‘sell’ rating with a lower target price of Rs 2,723 based on a target price-to-earnings multiple of 26.1 times its March 2026 estimates. This is at a 10 per cent premium to benchmark TCS, with the premium being lowered from 15 per cent due to perceived risk to margins.