Firstsource Solutions

The worst seems to be behind for Firstsource Solutions. Given its prospects,

 

FOR Firstsource Solutions, the past six quarters have been a challenging period as the Mumbai-based outsource company's business was adversely affected by slack in demand from the Western economies. This is also reflected in the performance of its stock on bourses during the period. The stock has remained rangebound, thereby underperforming the benchmark indices and other sectoral indices. However, a gradual uptick in the global demand is likely to benefit Firstsource given its investments in overseas delivery centers and its delivery capabilities in the healthcare and telecom segments.

BUSINESS:

Firstsource is a Rs 1,970-crore independent business process outsourcing (BPO) company in the country. It offers services across a variety of horizontals in the BPO space including call centre, transaction based services, collection of receivables and business analytics.

   It caters to three verticals, including healthcare, telecom and media, banking, financial services and insurance (BFSI). Share of healthcare segment in total revenue has gone up from 9% in FY07 to 36% in the March 2010 quarter post acquisition of US-based MedAssist Holding in September 2007. It had 24,860 employees as on March 2010. Concentration of clients in its revenue has significantly declined over a period of time, while contribution of existing clients has increased reflecting greater client engagement.

FINANCIALS:

Firstsource's consolidated revenue has increased at a compounded annual growth rate of 37.3% in the past four years. Net profit rose by 53% during the said period. In FY10, sales grew by 12.7% in Indian rupees and 11.2% in constant currency terms. The company reported 120 basis points of expansion in its earnings before interest, depreciation, taxes, and amortisation (EBITDA) margin in FY10 to 13.8%.

CHALLENGES:

The company's return on capital employed (ROCE) has dwindled to just over in 7.4% in FY10 from 12% in FY07. This is substantially lower and may put pressure on its financials during tough economic conditions. The company needs to take measures in this regard.

   The company's tax rate will increase from FY11 due to lapse of the STPI policy after March 2011. The policy exempts export revenue from corporate tax. The tax rate under such a scenario may be in the range of 20-25% for the company. The company needs to take steps to mitigate this risk by either locating its business centers in SEZs or in countries with tax holidays.

VALUATIONS:

The stock has more or less remained stagnant at around Rs 31 since the past four months. At this level, the stock trades at 10.7 times its trailing 12 month earnings. On the back of improving demand scenario, the company is likely to increase its revenue growth rate for FY11 from over 13% in FY10. This is likely to be better at around 15%.

   Further, the company is gradually improving its margins. The improvement, however, may face some hurdles such as stronger rupee against the dollar and possibility of higher tax rate going ahead. Given this, the company's net margin is likely to increase by a modest 50 basis points to 7.5% for FY11. This results into a forward P/E of 7.7 at the current stock price. Given the likelihood of a turnaround in its business, the stock looks attractive at the current levels.