Persistent Systems up 25% so far this year – here's why it could be among the best IT bets

Shares of Persistent Systems, an IT firm, performed strongly in the current year so far. The company's shares, which were trading at ₹3,870 apiece at the beginning of 2023, have risen by 24.54% to close at ₹4,820 today.

The strong rally in the stock was largely supported by the company's December quarter earnings, which were released on January 18, in line with analyst estimates. Following Q3 numbers, the stock started flying, reaching a new 52-week high of ₹4,950 per share.

In Q3 FY23, Persistent Systems reported a net profit of ₹238 crore, registering a growth of 35.22% YoY and 8.18% QoQ. The company increased its revenue from operations by 45.4% to ₹2,169.3 crore during the October-December 2022 period, from ₹1,491.7 crore in the preceding year.

The operating profit during the quarter came in at ₹402 crore, reporting a healthy growth of 9.1% on a QoQ basis and 60% on a YoY basis, while the operating margins improved by 200 basis points to 19% in Q3FY23 from 17% in Q3FY22. The company has seen its revenue and profits grow significantly in the last 12 quarters.

Domestic brokerage firms have praised the results, with many pointing to the company's ability to generate consistent growth in a challenging economic environment.

In its most recent research report, domestic brokerage house HDFC Securities maintained a positive outlook on the company. The stock was the brokerage's top pick in the mid-tier IT category, and the target price was lifted to ₹5,600 apiece from ₹5,230 earlier.

HDFC Securities said the company has doubled its revenue in the last three years and is well positioned to double revenue over the next four years, with earnings expected to accelerate even faster (24% EPS CAGR over FY23–25E) as the margin expands.

Strong order bookings provide growth visibility

Persistent Systems recorded its highest order bookings in the December quarter, and HDFC Securities expects deal bookings to continue to trend higher going forward. The brokerage expects bookings to revenue conversions to continue, estimating that historical bookings to revenue leakage are less than 6%.

"We believe that PSYS’ differentiation in software product development and stable outlook in the T1 account will aid outperformance in the hi-tech vertical, which faces industry headwinds," said the brokerage.

A stable outlook on T2 accounts ahead, including large BFS clients and no exposure of the company in the mortgage sub-segment, will also support growth.

Improved client mining

The company has improved its client mining by selling multiple service lines, which is getting reflected in its USD 5 million+ client count as well as growing bookings, including large deals.

The largest deal in Q3 was a USD 70 million TCV (USD 21 million ACV) by a US online retailer that followed large deals from Software AG in the prior quarters.

Over the last 2-3 years, the company has changed its commercial capabilities to drive large deals and multi-year bookings, aligned its verticals and horizontals (the setup of the GCP business unit, Microsoft business unit, and the Payments business unit), support proactive deals, market efforts (targeted events), and increased its partnership focus with hyperscalers, sourcing advisors, and the private equity channel, according to HDFC Securities.

Marching towards the next frontier

Persistent Systems is aiming for a USD 2 billion revenue run rate by FY27E (doubling in four years), with organic and inorganic sources contributing USD 100 -150 million. The European share of revenue is expected to reach 12–15% of total revenue (including inorganic) from 9% at present, the brokerage highlighted. 

Salesforce services are expected to generate 10% of revenue (from the current revenue rate of USD 130–140 million). Nearshore as a percentage of revenue will be higher than it is now, with Mexico and Costa Rica supporting the US and Europe, led by organic expansion in eastern Europe (re-badging deals).

Consumer and communications (telco software) are two new verticals that will emerge from the hi-tech and developing segments once the company reaches the USD 2 billion revenue target, it added. 

Leveraging strong partnerships

The company is focusing on five big partners including Microsoft, Salesforce, Google, Amazon, and IBM. Focus is on replicating Salesforce-like success (USD 130–140 million in revenue run rate) in Google Cloud Services. The GCP certifications have increased from 300 to 1,000 in less than a year, which will support wins and pricing.

Margin expansion

Persistent Systems is targeting 200-300 bps of margin improvement over the next 2-3 years, while HDFC Securities factored in a 150-bps margin improvement in FY25E over FY23E. The company's recent margin improvement was SG&A-led as the company rapidly expanded headcount to service the demand and built installed capacity.

Only 600–700 freshers have been deployed in projects over the past quarter of the total fresher intake of 3,000. Over the next two quarters, margins will be supported by improving the utilisation of the fresher pool into billable projects, which will be led offshore, the brokerage noted.

In addition, other drivers of EBIT margin will be a subcontracting optimization towards pre-COVID levels and a steady amortisation charge even as revenue increases (30 bps lever). Margin headwinds include normalised travel expenses (70–80 bps headwind).

Low exposure to Europe

The company has a cautious view of Europe for the next 6–9 months. The company's management expects Europe to contribute 12–15% of its revenue by the time it reaches USD 2 billion in revenue, up from the current 9%. Deal bookings in Europe have been strong, with USD 100 million in large deals in the last 2-3 quarters.

The M&A pipeline is not high currently but is expected to build up ahead to scale the European presence in the medium term.

The M&A pipeline is building up (not that high currently), and PSYS will continue with its strategy of tuck-in acquisitions of USD 15–50 million in revenue size to add capabilities in sub-segments or the intersections of the verticals.

Stock performance

Over the last one year, the stock has increased by 2.86%, while in the last three-year period, the stock delivered a staggering return of 587%, climbing from 701.25 apiece to the current level of ₹4,820. Furthermore, over the last five years, the stock has returned an astounding 535% to its shareholders.

26 analysts polled by MintGenie on an average have a ‘Buy’ call on the stock.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of MintGenie.