Buy 3 Small Cap IT Stocks As Recommended By HDFC Securities

Sonata Software Ltd.

Sonata Software (SSOF) was represented by Srikar Reddy (Chief Executive Officer) and Jagannathan Chakravarthi (Chief Financial Officer) at HDFC securities' 6th Annual IT Sector Investor Conference. It has a market cap of Rs 5,176.65 crore.

Currently, the stock is trading at Rs 572.80 apiece. Its 52 week low is Rs 457.59 and 52 week high is Rs 768.69. It has given 10.46% negative return in a year, whereas, in the past 3 & 5 years, it gave multibagger returns of 144.12% and 387.23%, respectively.

 

Sonata Software - Key takeaways

• Deal pipeline is strong, with no delays in decision-making. The Microsoft renewal took place in Q1FY23 and growth visibility has improved (~80% revenue visibility). Sell with Microsoft is a growth driver, Power Bi and Dynamics modernisation and implementation is a big opportunity. 
• Started demanding for price hikes in existing as well as new contracts. The average pricing revision is ~3-8%. There were also cases where the hike was ~15% but for specific niche skill-sets. 
• The company is still dependent on lateral hiring for niche skill-sets; freshers are mostly hired for basic work like testing, support, application support etc. 
• Attrition has stabilised, with joining to offer ratio having improved. The cost of replacement is still high, with new talent coming at ~20% higher cost. 
• The margin guidance for IITS remains at ~20-22% margin guidance, which is likely to achieve the top end of the guidance.
• Sub-con will remain at an elevated level; the company has ~4-5% of head count (200-250 people on sub-contracting). 
• Utilisation will improve with freshers getting into the billing cycle; the company plans to hire ~600 freshers in FY23E vs 400 in FY22. 
• Wage hike is done in Q1, next wage hike cycle in Q4, which is the normal cycle of wage increase. 
• The new CEO is focusing on improving large deal wins, offerings, solutions and the partnerships ecosystem. 
• The recovery in travel is slower than expected; TUI is not in investment mode only getting the volume-linked revenue. The recovery is expected in 2HFY24E.

Sonata Software - Views & Valuation

Sonata's Microsoft portfolio (digital services + dynamics 365 is ~50% of IT services segment) is driving growth. The company is optimistic about the Microsoft channel and it can grow ~15-20% YoY over a longer period. "We expect IITS growth of +16.8/12.4% and DPS growth of 27/20% for FY23/24E. IITS margin will be at 22.4/22.6% and DPS margin at 3.5/3.6% for FY22/23/24E respectively. Revenue/EPS CAGRs for FY22-24E are expected to be +14.6/15.5%. Our target price is INR 870, valued at 18x Mar-24E EPS. The stock is trading at a P/E of 19.2/16.4x FY23/24E (5y/10Y average P/E of 15/11x). Maintain BUY," the brokerage has said.

Zensar Technologies Ltd.

Zensar Technologies (ZENT) was represented by Sachin Zute (Chief Financial Officer) at HDFC securities' 6th Annual IT Sector Investor Conference. It has a market cap of Rs 5,176.65 crore.

Currently, the stock is trading at Rs 231.70 apiece. Its 52 week low is Rs 221.75 and 52 week high is Rs 587. It has given 60.52% negative returns in a year, whereas, in the past 3 & 5 years, it gave 3.86% and 51.68% positive returns, respectively.

Zensar Technologies - Key takeaways

• BFSI is witnessing strong demand in North America and Africa region. The investments made in BFSI vertical is resulting in deal wins and better visibility. Cynosure (insurance vertical) is also seeing deal closures. 
• Strong growth momentum is witnessed in advanced engineering, data engineering and platform services. 
• There is weakness in pockets of retail vertical, with some of the retailers cutting back spends on experience services. 
• The hi-tech vertical is also witnessing softness and there are delays in decision making. The top client will remain stable and there is no loss of wallet share. 
• Sanjib Talukdar (ex-Cognizant veteran) has joined as the head of insurance vertical. He will be based out of New Jersey and will head the insurance solutions group. 
• Manikandesh Venkatachalam (ex-Mindtree) has joined recently as the head of Strategic Growth Area. He will spearhead the data engineering and experience services for Zensar. 
• The margin recovery trajectory will start from Q4FY23E. The wage hike is planned in Q2FY23 and the impact will be similar to last year's. The medium term margin target is mid-teens, likely to be achieved in 2HFY24E. 
• The fresher hiring program will continue and the fresher deployment will increase utilisation. The sub-con cost will be at an elevated level and will act as a margin lever in FY24E.

Zensar Technologies - Views & valuation

Zensar has historically struggled with portfolio issues, revenue leakages, low single-digit organic growth, and inferior margin profile vs. peers. "We expect USD revenue growth of 12.2/10.1% and EBITDA margins of 11.8/13.6% for FY23/24E, resulting in revenue/EPS CAGRs of +11/5% over FY22-24E. The stock is trading at a PE of 17/12x FY23/24E EPS, a discount of ~50% to the mid-tier IT median. Our target price is INR 315, valued at 16x FY24E EPS. Maintain BUY," the brokerage has said.

Teamlease Services Ltd.

Teamlease Services (TEAM) was represented by Ramani Dathi (Chief Financial Officer) at HDFC Securities' 6th Annual IT Sector Investor Conference. It has a market cap of Rs 5,491.57 crore.

The stock is trading at Rs 3,212.05 apiece. Its 52 week low is Rs 2,910 and 52 week high is Rs 5,550. It has given 30.8% negative return in a year, whereas, in the past 3 & 5 years, it gave 14.69% and 100.07% positive returns, respectively.

Teamlease Services - Key takeaways

• Teamlease will deliver at least ~20% organic revenue growth, driven by ~15% volume growth in the general staffing segment. The hiring activity has improved across BFSI, manufacturing, telecom and consumer verticals. The company added 13k headcount in Q1 and the momentum will continue, boosted by festive demand and lower attrition. 
• The sourcing of talent is being done from the teamlease.com platform, which is now contributing ~40-50% of volume vs 15-20% pre-COVID. The aim is to take it up to 70-80%, which will bring down the cost of hiring. 
• Teamlease has ~77% of the headcount on fixed mark-up model, the PAPM has not increased in the last three years; thus, the general staffing gross margin has come down. The general staffing EBITDA margin will remain in the 1.8-2% range. 
• The average salary hikes for associates have risen to 10-12%, from 4-6% earlier. Teamlease has given ~12% hikes to core employees, up from 7-8% earlier. 
• The specialised staffing volume was boosted by huge demand for IT/Gig talent. The hiring activity is cooling off but the demand for contract is going up vs permanent hiring. 
• EBITDA margin for general staffing will be in the 1.8-1.9% range, HR-tech will be at 10% and specialised staffing will be at 8-9% margin. 
• The 80JJAA tax benefit will continue in the medium term, no indication from the government in relation to withdrawal of 80JJAA tax benefit. 
• The company aims at improving its realisation by way of cross-selling its value added services through Edtech and HRtech.

Teamlease Services - Views & valuation

The Brokerage said, "We believe the company is set to deliver ~20% organic growth, driven by factors such as (1) growth in general staffing and NETAP trainees associate count; (2) vendor consolidation; (3) formalisation of jobs; and (4) change in labour laws. There is scope for margin expansion through productivity benefits, restructuring of HR services and improving the business mix. Our target price of INR 4,110 is based on 35x FY24E EPS. Maintain BUY."

Disclaimer

Investing in equities poses a risk of financial losses. Investors must therefore exercise due caution. Greynium Information Technologies, the author and the brokerage firm are not liable for any losses caused as a result of decisions based on the article.