Shares of Zensar Technologies are down 48 percent from its 52-week high of ₹587 that it hit on September 16, 2021. This sharp fall in the stock is in-line with the weakness in the overall sector and the market due to concerns about the potential impairment of IT spending due to global macro concerns.
Brokerage firm JM Financial has upgraded the stock to a 'buy' from a 'hold' but has cut the target price to ₹400 from ₹470. Weakness in global macro is a key risk for the stock which can impair near term IT spending.
"While there is increasing concern on macro challenges for Indian techs due to the slowing global economy (and a potential US recession), we find the improvement in internals for Zensar encouraging as is reflected in (1) much stronger exit for FY22 (and thereby should aid FY23 revenue growth, (2) Investments in sales and delivery leadership across key verticals like financial services and Retail (which is showing up in terms of improving client metrics performance) and (3) improving order booking and focus on fresher hiring," said JM Financial.
"We also find the current EBITDA margin profile of 14-15 percent far more defendable as compared to the elevated levels in the second half of FY21 which should cushion the risks of further earnings downgrades. Valuations are back to 5-year mean after a nearly 45 percent pullback in year-to-date," the brokerage firm added.
The brokerage firm highlighted that Zensar has continued to underperform tier-II peers on growth in FY22, but it is exiting FY22 on a stronger note which should help the company reduce the growth differential in FY23.
On the front of earnings, Zensar had seen a significant improvement in EBITDA/EBIT margins through FY21 aided by natural cost savings due to Covid in addition to aggressive cost containment measures undertaken by the company which included even headcount rationalisation, said the brokerage.
While this drove margins to artificially high levels during FY21(Zensar saw EBIT margins improve by 520 bps YoY in FY21), it impacted the company’s ability to fulfil demand as client spending picked up sharply in 2HFY21.
Zensar has made course corrections on this front with a significant pick up in hiring through FY22. This has driven normalisation in Zensar’s operating margins in recent quarters with the company’s EBIT margins at 10.1 percent in the second half of FY22.
"We believe that the current margin profile is more defensible for the company and thereby see limited risks of margin reset led earnings downgrades," said JM Financial.
The brokerage firm said it had a strong faith in a ‘resilient and accelerated IT spend with increasing offshore intensity’ thesis and believed that the revenue growth for the sector will see a limited impact in FY23.
In addition, if the recent rupee weakness were to sustain, it may limit margin headwinds from supply side pressures and resumption in travel/facility expenses for the sector as a whole.
"We moderate our revenue assumptions slightly as well as lower margin assumptions (build in EBIT margins at 10.6 percent/10.9 percent for FY23/24 versus 11.1 percent in FY22) thereby cutting FY22-24E EPS by 5-6 percent," said the brokerage.
Disclaimer: The views and recommendations made above are those of the broking firm and not of MintGenie.