EXLS - ExlService Holdings: Good Quality Slightly Overvalued

2024-01-07 22:48:31 ET

Summary

• ExlService Holdings is a data analytics and digital solutions firm with over 50,000 employees and operations in six countries.
• The company has experienced strong growth since its IPO in 2006 and has a solid track record of profitability.
• The stock is slightly overvalued today, as the market is giving it a bit too much credit for what have been very good results lately.

ExlService Holdings ( EXLS ) is an American data analytics, digital operations, and solutions firm. They have over 50,000 employees, in six countries, with over 50 offices. The digital operations and solutions segments are broken down into insurance, healthcare, and emerging businesses. Below is the total revenue breakdown:

They were founded in 1999 and became publicly traded in 2006. Below are the returns since IPO and the period of best returns:

Now, let's look at the return metrics versus peers:

Source : Data analytics on a global basis is projected to grow at 26% compounded till 2030.

Capital allocation

Let's now see how capital has been allocated over the past decade:

Source

They've never paid a dividend, and growth by acquisition has always been a key component. In spite of the repurchases, the share count hasn't been reduced nearly enough to help boost EPS. I don't expect this to change any time soon, so I won't factor in a dropping number of shares outstanding to any extent that will affect EPS.

Risk

EXLS is a good growth company with minimal risk from a very fundamental perspective. The worst-case scenario would be slower growth and a continual loss of market share. Growth via M&A has always been part of their strategy, and this of course brings the risk of buying businesses that aren't as accretive as expected, paying too much for them, and/or funding them in a way that causes longer-term damage.

They do use a bit of debt to fund their acquisitions, but currently, I think the balance sheet is safe with $122.6 million in cash and $160 mil in long-term debt.

They performed well through the pandemic and beyond. Growth declined slightly at the beginning of the pandemic, but they remained profitable throughout. The riskiest aspect for investors is in the price paid, not in misjudging the quality of the business.

FQ3 Earnings

Let's take a quick look at recent earnings history:

I don't see next quarter being much different than the last few. They have proven they can still execute during every phase of the pandemic and into the current environment. A recession will affect their business, but not to the extent of being unprofitable. It would merely slow their revenue and earnings growth.

Valuation

Shares of EXLS hit an all-time high in November of 2022. The price didn't get too crazy as many other stocks did in 2021, so it didn't have the massive correction that so many overvalued names did in 2022. Shares are currently down 20% from that all-time high.

We will take a look at the multiples from first a historical perspective, then currently compared to peers:

Things are already looking pricey from both of these perspectives. So let's look at the dcf model to see if this stock is truly overvalued or not:

I'm conservatively bullish on the company, I see it being somewhere between good and very good, whereas the market has valued it as being great. For the long-term earnings growth, I used a very conservative number after five years, because it's hard to predict the demand for their services that far into the future. I also think they will need to begin returning capital to shareholders within the next five years, so I'm not counting on EPS growing at the same rate long term. Over the TTM, they've hit record-high revenue, operating profit, net income, and ROIC. Seeing a high ROIC is a huge part of what I look for, but it's unfortunately the most likely to mean revert. I don't see anything in this company that assures me it has entered a new era of sustainably high returns on capital.

So I'll be giving this stock a "hold" rating, and seeing if there will be any decent dips in the future. The only bad thing about beating every quarter is that the share price will never have massive short-term drops unless a major negative event occurs.

Conclusion

EXLS has been a very good growth stock, returning almost 30x from the bottom of the GFS till 2022. Their acquisition strategy has worked well so far and they haven't overleveraged along the way. It's clear that they are a good company with a strong probability of growing earnings no matter the economic environment, and they deserve credit. The problem is that the market is valuing them as slightly better quality than is really the case. This leads me to give the stock a "hold" rating and keep a watchful eye on it.

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