EXLS - ExlService Holdings: Demand Trends And Outlook Both Look Healthy

2023-05-23 16:53:14 ET

Summary

• EXLS exceeded expectations in 1Q23, with impressive revenue and profit figures, and also raised its full-year guidance.
• EXLS is well-positioned to leverage generative AI. By harnessing AI capabilities, EXLS can expand its total addressable market, strengthen its competitive advantage, and improve margins.
• I believe the stock has an attractive relative valuation vs the past due to its improved fundamentals and size.

Investment thesis

ExlService Holdings ( EXLS ) is a global analytics and digital solutions company that partners with clients to improve business outcomes and unlock growth. I continue to recommend a buy rating for EXLS after the very strong 1Q23 results. EXLS had a strong beginning to FY23, surpassing expectations with impressive revenue and profits. Notably, the company raised its full-year forecast due to strong demand for its key digital operations and analytics products. Furthermore, I believe the overall demand trend remains positive as EXLS gained 16 new clients in the first quarter of 2023, spanning various industry segments. This confirms my belief that the demand remains diverse and resilient, despite growing economic uncertainty. Overall, I continue to see EXLS's underlying growth being healthy, which, along with potential margin improvement, should help improve sentiment (which it did previously when the stock surged to near $180). The valuation today is also much more attractive on a relative basis vs the last time I wrote about it. At 21x forward PE with better business fundamentals, I believe the stock will yield a good upside as it continues to grow its earnings.

Growth outlook/guidance

As my buy rating relies on EXLS earnings to grow, it was a relief to know that the underlying demand trends remain very healthy for EXLS, in my opinion. From a logical point of view, EXLS should benefit from this uncertain environment as more businesses cut costs and outsource business functions that do not require a fixed position. For instance, customers care contact is one function that typically gets outsourced. I believe this was already hinted in the 4Q22 earnings call when management mentioned that their Operations Management and Solution business grew at a healthy rate in FY22. Given the uncertainty in the macroeconomy has not faded, I expect EXLS to continue seeing healthy growth in that segment. In addition to being positive for EXLS's operations, the banking industry's turmoil and uncertainty bode well for the company as a whole. If the macro environment remains uncertain, I anticipate that EXLS Analytics will reap the benefits of an increase in risk management work for banking clients. Finally, the best indicator of demand and growth is management guidance. After the strong 1Q results, management has raised the FY23 guidance of revenue growth from 12.5% to 14% at the mid-point.

AI

In the call, management has spent some time addressing the concerns of generative AI and how the business is positioning itself to benefit from it. In my opinion, generative AI is an opportunity for EXLS and the BPO industry as a whole. I believe that by leveraging AI, EXLS can increase their TAM, competitive advantage (barriers to entry), and further improve margin. I expect the generative AI capabilities to be applied to several back-office applications that are repetitive in nature or have a standard yes/no route. The most obvious one would be productivity enhancement for customer service agents while they are talking with end consumers . Another use case that I could think of is searching for data in large databases - particularly for legal functions. It would make the life of a paralegal/lawyer to search for case studies much more easier (think of how ChatGPT works). Also, I think the use of AI will significantly reduce the burden of programmers that need to rewrite basic codes. The beauty is these functions and use cases can be found in almost every industry across finance, manufacturing, industrials, etc. While it is true that anybody can whip up an AI/ML machine, it is not the case for replicating EXLS business. The true worth of EXLS is its customer relationships, network, and presence in multiple markets. As such, I believe EXLS is in a good position to better leverage the use of AI to help enterprises, as compared to just an AI provider. That said, I also understand the bear case that investors might be worried about. The narrative would be something along the lines of "With generative AI, businesses might not need EXLS anymore since they can do it themselves". There are merits to this, however, I would point also point the bears to Robotic Process Automation as a case study. RPA was a revolutionary thing that could ease the businesses' burden of repeating mundane back-office applications. RPA should have wiped away a chunk of the BPO industry, instead, it became a tailwind as BPO providers can now offer more services at a reduced cost.

Valuation

Given the healthy underlying demand, improved guidance, a potential extension of the growth runway, and margin improvement (due to AI capabilities), I believe EXLS will continue to grow earnings at a healthy rate. I believe the opportunity exists today simply because of the current state of investment sentiment. I expect the share price to respond accordingly if EXLS continues to grow in line with or even ahead of consensus.

Conclusion

I maintain a strong buy rating for EXLS based on their impressive performance in 1Q23 and positive growth outlook. The underlying demand trend remains healthy, as evidenced by the addition of 16 new clients across various industry segments. This resilience in demand, despite economic uncertainty, confirms the broad-based appeal of EXLS's offerings. Furthermore, the utilization of generative AI presents an opportunity for EXLS to expand its market presence, improve margins, and enhance its competitive advantage.

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