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MOSL: QUESS CORP (Neutral)-Margin pressure should continue; Weak outlook in most of the segments

Quess Corp: Margin pressure should continue; Weak outlook in most of the segments - Maintain Neutral

(QUESS IN, Mkt Cap USD1.3b, CMP INR620, TP INR590, 5% Downside, Neutral)

 

• Robust organic revenue growth (+31% YoY) was almost entirely driven by general staffing. However, this has not translated into equally strong growth in EBITDA/PAT. Lower mark-ups in the recent contracts have been driving a secular decline in general staffing margins over the past few quarters. In addition, (i) profitability challenges at Monster/Digicare and (ii) potential headwinds due to recent the Supreme Court's judgment (Mar'19) on PF calculation should translate into continued margin pressure. As cash conversion has already reached the aspirational level (OCF/EBITDA = 50%), the scope for further improvement here is limited.
• We downgrade our EPS estimate for FY21-22 by 8%-11%, given the weak outlook on margins. P/E multiples at a steep discount to Teamlease (57%), coupled with some of the recent positive developments, have led to a sharp re-rating (22%) over the past three months. However, we remain cautious. 

Concentrated growth; margin contraction

• Organic/overall revenue increased 31%/36% YoY, largely led by general staffing segment, while most other key segments remained modest at best (GTS: +5% YoY; Conneqt: +13% YoY; Facility Management: +11% YoY; Industrials: -15% YoY; Internet: -14% YoY).
• Excluding the impact of Ind-AS 116 and the inorganic contribution from Allsec Technologies, EBITDA growth was weak at 5% YoY.
• Margin contraction within general staffing was the key overhang on overall margins. This could have been driven by lower mark-ups in large deals.
• Despite the consolidation of higher-margin entity (Allsec), the PBT margin contracted ~30bp YoY to 2.7%. This was driven by the sharp increase in interest expense and D&A cost, which can be partly explained by acquisitions.