Why You Should Make a Profit on Persistent Systems Stock

It has been a great year for India’s IT industry. The top and top companies skillfully maneuvered through the initial impact of Covid and then capitalized on the increased digitization spending in the Western world, specifically the United States. Persistent Systems is also one of those companies that has had an exceptional year.

Thanks to good growth, the stock has returned 271% over the past year and around 475% from its pre-Covid highs in February 2020. After that rise, it is now trading at a rich valuation of 41 , 9. times its next twelve-month EPS, which now shows a significant premium of 140% over its 5-year average and 81% over its 2-year average. While growth has also accelerated in recent quarters and the outlook is solid for the current fiscal year and next based on recent trends, given the increased valuation, investors would be better off booking the profits and cash out the winnings. CY22 is shaping up to be a year of macroeconomic uncertainty. Inflationary pressures and the withdrawal of monetary stimulus are weighing on macroeconomic engines for the next two years. The impact of the unwinding of the stimulus measures on stock market valuations is also an important factor to consider. At current levels, the stock offers no margin of safety for the risks that may arise, making the risk / reward ratio unfavorable.

Business and outlook

The company’s business includes – one, the IT services segment (83 percent of FY21 revenue) – product engineering services and platform-based solutions; and second, the IP-based software product segment (17 percent of the business). Its product segment is a differentiator from some of its peers – revenues can be spotty but come with better margins. In terms of business verticals, BFSI accounts for 31 percent of revenue, Tech and Emerging Verticals (50 percent) and Healthcare (19 percent). It is heavily indebted in the United States with 79 percent of income coming from North America.

In FY21, the company reported revenue of 4,188 crore – USD revenue growth of 13% and INR revenue growth of 17% from FY20. EBIT margins improved by nearly 300 basis points, from 9.2% to 12.1%. This is mainly due to reduced sales and marketing spending, a trend seen across many IT companies in the year affected by Covid. Driven by revenue growth and expanding margins, profit increased 32% for the year to reach 451 crore.

The momentum also continued in FY 22 with revenue of 2,581 crore in the first half of FY 22 – growth of 30.7% in USD and growth in INR by 29.1%. The EBIT margin was 13.7% and PAT increased 63% year-on-year to 313 crore. For the Full Consensus of FY22 (Bloomberg), the expectation is that both revenue and PAT will increase by 33% and 55%, respectively. While business is expected to remain strong thanks to strong contracts won by the company in recent quarters, however, momentum is expected to falter with consensus forecasting revenue and PAT growth of 22% and 23% respectively over the course of the year. the FY23.

Given the acceleration of commercial dynamics compared to historical trends, a premium for historical valuation is justified. However, this is more than sufficiently factored in with a premium valuation of 140 percent over its 5-year average and with stock trades at a PE ntm of 41.9 times and a PE FY23 of 39 times. While growth is expected to remain good, there is not much clarity on how growth rates will move beyond FY 23 given macroeconomic uncertainties.

No safety margin

His five-year income CAGR between FY15-20 was 14%. The 20-23 fiscal year revenue CAGR is expected at 24%. According to a NASSCOM report, India’s IT services industry can reach $ 300-350 billion in annual revenue by fiscal year 25. This implies a 13 percent CAGR for the industry during this period. Against this backdrop, it would be difficult for the persistent FY20-23 CAGR growth to sustain beyond FY 23, given that the industry is expected to grow at around 13%. The current assessment can only be justified if growth will trend above 20% for a few more years beyond FY 23 and margins continue to improve. Both seem less likely.

Another potential factor to note is that while the company recently improved its EBIT margins to around 13 percent, they are significantly lower than those of Tier 1 players like TCS (26 percent), Infosys (22 percent ) and HCL Tech (20 percent). Firms with lower margins are at higher risk in the event of an economic downturn, currency volatility, or increased competition. For example, the growth of the Tier 1 IT service companies mentioned above is much lower than that of Persistent. But since their margins are higher, if competition intensifies, they are better equipped to sacrifice growth margins and gain market share.

Its current dividend yield is also low, at around 0.5%. Its return on free cash is expected to be just 1 percent for fiscal 22 and 2 percent for fiscal 23. Returns on capital to investors, which are generally based on free cash flow, will therefore be less than. the average. It also does poorly compared to Tier 1 IT companies like those that return a significant portion of their free cash flow to investors each year in the form of dividends and redemptions.

Considering the risks of lower margins and lower returns on capital, Persistent’s current valuation, which is higher than Tier 1 IT service companies (PE NTMs between 25 and 35), is also unsustainable and provides another reason for become cautious about the title.

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