Stock Pick From The IT Sector

HERE IS WHY:

• FOSL has clocked in a 16.76 per cent CAGR in revenues in the last five years
• Aims to reach a EBITDA margin of 15 per cent by the end of FY15 (from 9.91 per cent for FY13)
• Available at an attractive valuation at a PE of 6.25x

BPOs are considered to be fairly commoditised businesses. Not many in this space will ever be able to create long-term value for stakeholders. But when you look at the Indian listed space, there is one company which looks fully geared to create good value for its stakeholders going forward.

Firstsource Solutions (FSOL) is a company providing customer management, collections management, data processing and business transformation services across the globe. It clocked revenues of USD 517 million in FY13. 80 per cent of FSOL’s revenues come from North America and UK with 99 per cent coming from the verticals of Healthcare, Telecom & Media and BFSI. With the implementation of ‘Obamacare’ (The Patient Protection and Affordable Care Act) in the US, the healthcare vertical is expected to act as a major growth driver for FSOL over the next three years. Moreover, the telecom and BFSI segments in the UK are also expected to provide substantial growth traction for the company.

The revenue growth prospects for the sector seem quite bright. The company had been facing several issues in the past, which are currently on their way to being resolved. All this will improve FSOLs profitability and strengthen its balance sheet. Over the last five years, FSOL has seen robust growth in its revenues, clocking a CAGR of 16.76 per cent to Rs 2818.54 crore. Of concern however, was its profitability. An operating profit margin of 9.91 per cent for FY13 seems to draw out the charm of a BPO company.

However, FSOL has been on a drive towards margin improvement and aims to reach 15 per cent in EBITDA margins by FY15. It is terminating low margin accounts in customer management, ABU and Provider business segments. This will lead to pressure on its topline growth (in addition to existing pressures from the collections business), however, it would largely be offset by traction in other segments. But the motive of improvement in profitability would be achieved.

Apart from this, the company also has a net long-term debt position of USD 167-168 million on its US books. The company made a repayment of USD 11.25 million towards its first principal instalment of the term loan in Q1FY14. It will be repaying USD 45 million of this every year, through internal accruals, without having to refinance any of the outstanding debt. The necessary cash flows for servicing the interest and principal repayment is being driven by the strong performance in the company’s healthcare business.

The fact that the debt is denominated in foreign currency brings about the question of being hurt by the massive depreciation of the rupee. However, as most of the company’s revenues come from the US and UK, and, this provides for a natural hedge, thus offsetting the impact of cross-currency fluctuations.

FSOL operates at a seat fill factor of 80-81 per cent. The company plans to reach a fill factor of about 93-94 per cent before looking at building capacity. The management of the company believes that it will be able to support USD 100 million plus of future growth with incremental capital expenditure and not greenfield expansion.

Overall, tremendous potential for growth in a profitable manner, and the availability of the stock at a PE of 6.25x makes for a great investment in FSOL for a two year horizon and a potential upside of 20 per cent.