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Krishnan Thiagarajan

Mr Atul Nishar (right), Chairman, and Mr Rusi Brij, CEO and Vice-Chairman... Modest revenue growth in the first quarter, but a good year ahead — Paul Noronha.

INVESTORS can consider taking fresh exposure in the Hexaware Technologies stock at the current post-stock-split price levels. Any declines in the broad markets may be used to enhance exposures. The stock, however, is appropriate only for investors with an appetite for risk. Despite a relatively modest revenue growth in the first quarter of 2005, we are revising our "Hold" recommendation made in early February to a "Buy" on account of two key factors.

One, the senior management has clarified that the company will be able to meet its original financial guidance even if Oracle were to exercise the transfer option over the India Services Centre (ISC) for PeopleSoft, set up under the BOT model by Hexaware in 2003. This uncertain variable had cropped up following the Oracle-PeopleSoft merger. PeopleSoft is one of Hexaware's key clients from which it derives nearly a third of its revenues. About 13 per cent comes from the PeopleSoft ISC that can be taken over by Oracle, if it chooses to. Oracle, however, has not formally committed its intent on ISC to Hexaware so far. For 2005, the company has projected a revenue growth of 40 per cent at $170 million and 80 per cent rise in post-tax earnings to $ 25.2 million.

Two, the order-book position at $190 million at the end of the first quarter remains quite robust, with orders worth nearly $95 million signed over the past nine months. The healthy addition to the order-book reinforces that the existing business model of Hexaware that is focussed on the "under-served" markets such as the PeopleSoft suite, transportation sector and clients based in Germany is working well.

At the same time, Hexaware remains exposed to risks faced by most medium-sized companies. These are high client concentration and client replacement risk, especially among the top five clients; relatively high revenues from PeopleSoft, which it has been reducing through exposure to SAP and Oracle; and stiff competition from its frontline peers across all its verticals. On the external front, any weakness or volatility in the US geography can exert a negative influence on growth from Fortune 500 customers.

First quarter highlights

Hexaware's first quarter ended March 31, 2005 proved to be a relatively modest one on the revenue and post-tax earnings front, but other operating metrics improved steadily. After seven straight quarters of double-digit growth in dollar terms, the company recorded a relatively modest 6.3 per cent growth in revenues in dollar terms and 4.5 per cent growth in rupee terms.

According to the senior management, this slowdown in revenue growth is on account of delayed start of three projects on account of logistics and visa issues. On account of the slower revenue growth, the company will be expected to clock 9 per cent growth over the next three quarters to achieve its revenue guidance.

The operating profit margin improved to 16.9 per cent, up 0.6 percentage points aided primarily by an improvement in the offshore contribution and lower SG&A (selling, general and administrative expenses).

The post-tax earnings growth rate at 8.3 per cent has been relatively lower the previous quarters, though the profit margin has improved by 0.5 percentage points to 14.2 per cent. To meet its earnings guidance, Hexaware will continue to focus on improving its offshore contribution, lowering SG&A expense and increasing utilisation (which hovers at over 70 per cent). As the billing rates have also remained stable over the last few quarters, there is good scope for the other operating elements to push up post-tax earnings growth.

The revenue per client is increasing steadily as well as contribution of clients in the $1 million and $5 million bracket. Considering a swelling list of 35 Fortune 500 customers, Hexaware will have the flexibility to mine or churn its client list based on client's IT budgets and scale-up potential.

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