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Update on Eclerx Services Ltd. by Equirus Securities

Execution pickup key to re-rating; retain ADD

eClerx Services’ (ESL) reported marginally below revenues (at US$ 51.2mn, 0.7% below EE) while Ebitda margins were better (at 22.1%; 261bps above EE of 19.5%). Revenue miss was led by Europe (-20.4% yoy; had one-time higher revenue in 4Q18) despite 3.4%/7.6% qoq/yoy growth in the US. CC revenues grew 1.9% qoq (0.7% in 3q) while FY19 CC revenues grew 1.4%. Commentary suggests yoy improvement in pipeline conversion across verticals, increase in deal sizes, new logo wins, client mining (3 client added to US$ 500k+ bucket in 4q) could help sustain momentum and helps retain ADD rating with a Jun’20 TP of Rs. 980 (Rs. 1,135 earlier) set at 14x (no change) Jun’20 TTM EPS of Rs 72.1. However, slower than anticipated recovery, higher onsite costs leads to trimming of estimates and target price.

Client mining improved; top 5 weak:

Sequential growth was led by top 6-10 (grew 11.1%/8.7% qoq/yoy) and emerging customers (10.3%/-5%) while top 5 (-3.9%/-3.2% qoq/yoy) were weak. Client mining was better with 4 clients added in US$ 500k+ bucket while US$ 1mn+ bucket saw reduction of 1. Growth across geos was led by North America (65.1% revenues; 3.4% qoq) while Europe (28.6%; +0.7%) and RoW (6.3%; -5.6%) were weak. Pipeline across businesses continues to be healthy with company highlighting that demand pipeline is strong yoy and could reflect in FY20E. That said, we are trimming our FY20E revenue estimate by 4%.

Margin recovers sharply qoq (down yoy) and beats EE:

EBITDAm improved 348bps qoq (even as it was down 16bps yoy to 22.1%) and was 261bps above EE of 19.5%. For the full year FY19 EBITm declined 487bps led by headwinds including higher delivery cost (-430bps), G&A (-140bps) and forex (30bps) offset by tailwinds from lower depreciation (40bps) and S&D leverage (60bps). Management highlighted that tailwinds from lower CSR and facility costs would be offset by wage hike due in 1Q while higher additions in onshore and higher onshore mix could weigh on margins. Hence, we trim our FY20E margins by 85bps to 24.2%

Retain ADD but execution needs to pick-up:

Demand environment across customers seems to be improving and is reflected in the commentary while growth, rupee could partially offset significant margin headwinds from rising onsite mix. Though valuations continue to be reasonable (as shares trade at 15.1x trailing pe as against 10-year avg. of 16.4x). FY19 was a washout year and execution pick-up is key to rerating. Higher than anticipated increase in onsite contribution and pace of roll-offs are key risks to estimates while recurring buybacks could continue to anchor shares.


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