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Margin woes persist at Persistent Systems

Margin woes persist at Persistent Systems
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First Published: Tue, Apr 19 2011. 10 48 PM IST
Updated: Tue, Apr 19 2011. 10 48 PM IST
Within three months of its listing in April 2010, Persistent Systems Ltd’s shares had risen by more than 50% compared with its issue price of Rs 310. The CNX IT (information technology) Index of the National Stock Exchange fell marginally during this period, resulting in an outperformance of around 55%.
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This was before the firm reported quarterly results for fiscal 2010-11 (FY11). Since then, its shares have shed most of those gains. At current levels, the shares have risen 27% compared with their issue price, while the CNX IT Index has risen by around 12% since the date of the stock’s listing.
The company’s results announcement for the year ended 31 March explains why investors were disappointed. Revenue grew at a healthy rate of 33.5% to $168 million (Rs 750 crore today) last year. However, expenses grew at a much faster pace; as a result, earnings before interest and tax (Ebit) rose by a mere 1.9% to $26 million. Ebit margin fell by around 400 basis points, primarily due to a 420 basis points jump in employee costs as a percentage of revenue. One basis point is one-hundredth of a percentage point.
The company’s performance last year is symptomatic of most mid-cap IT firms. As demand returned to the sector, employee attrition rates picked up sharply last year, forcing firms to give substantial salary hikes to retain employees.
Persistent Systems followed up a hike given last year with another hike in January to tackle the high attrition it was facing. So, even though revenue grew smartly by 9% sequentially in the March quarter, Ebit fell by around 13%, even after excluding a write-off for doubtful debts.
The company has predicted an organic growth of 24% for the current fiscal and overall growth of 29%, including the acquisition of Infospectrum India Pvt. Ltd. Assuming a 2-3% increase in pricing, the firm expects to maintain operating profit margin, thanks to the addition of about 1,000 freshers in the first two quarters. Besides, it is anticipating that a 7-9% salary hike will suffice in FY12, considering the 10% hike in January.
If these assumptions play out, operating profit growth would be much better this year. But growth at the net profit level will be flat again, thanks to a surge in tax rates. With the sunset clause for software technology parks coming into effect this year, tax rates will rise sharply for the company.
Investors, therefore, would have to wait for another two years before they can see a meaningful growth in earnings beyond the levels the company reached in FY10. But valuations are reasonable at less than 11 times trailing earnings and the company’s strong revenue growth should eventually translate into profit growth. Investors willing to wait may well be rewarded.
Graphic by Ahmed Raza Khan/Mint
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First Published: Tue, Apr 19 2011. 10 48 PM IST