EXLS - ExlService Holdings: Reiterate Buy Rating On Strong Earnings

2023-08-01 01:50:06 ET

Summary

• ExlService Holdings remains a buy due to its strong fundamentals and upward revised guidance indicating underlying demand.
• 2Q23 results showed 17% constant currency growth in revenue, beating consensus, with increased non-GAAP EPS and boosted margins.
• While Analytics growth slowed, other solutions like digital ops management and insurance performed well, and the focus on generative AI presents future growth opportunities.

Overview

My recommendation for ExlService Holdings ( EXLS ) is a buy rating, as I believe the fundamentals will remain strong. Management's revised guidance upward was also a strong indicator of underlying demand. I see the drop in share price as another opportunity to size up any existing positions. Note that I previously gave a buy rating as I believed the overall demand trend remained positive for EXLS and the valuation was relatively more attractive than when I first wrote about it.

Recent results & updates

Constant currency growth for EXLS 2Q23 revenue was 17%, a 6pt slowdown from 1Q23 but still $5 million ahead of consensus. This resulted in a 22% increase in non-GAAP EPS to $1.82, which was significantly higher than the $1.68 predicted by consensus. Not only did sales push the number higher, but widespread cuts to expenses boosted margins.

It's probably not shocking that Analytics saw a slowdown in growth. On a constant currency basis, growth in analytics slowed to 13% from 16% in 1Q23. I believe that this slowdown in growth can be attributed in large part to the over-exposure to the financial and consumer discretionary sectors. Despite management's forecast for continued Analytics softness in the segment, I anticipate growth to resume in the fourth quarter as the segment benefits from the ramp of a new business win in healthcare marketing analytics for Medicare Advantage. In addition, I'd like to mention that EXLS's other solutions, including decision analytics services, data management, and payment integrity, are still experiencing very good levels of demand. Also, there is another growth catalyst in the road up ahead - generative - which should lead to an increase in demand for EXLS services.

There is strong demand from clients for using generative AI to achieve these priorities. As our clients plan their generative AI investments, they need a partner who has deep business domain knowledge, can harness the data, create the appropriate use cases and implement them as part of the workflow. Our clients view EXL as an ideal partner, who combines all these capabilities. Rohit Kapoor - 2Q23 call

While growth in Analytics slowed, 21% organic growth was seen in digital ops management during the same time period. Insurance saw sustained growth, and Emerging Business proved resilient, both of which contributed to the solid performance. Positive trends in bookings bode well for the segment's potential for growth over the next few years. This is the ninth consecutive quarter of double-digit revenue growth, a remarkable feat that speaks volumes about the quality of EXLS's offerings and its future growth profile. Given the macro situation, I anticipate growth to continue growing by double digits as customers prioritize efficiency gains and cost reductions.

Looking ahead, I am very pleased to see that EXLS has increased its revenue guidance range for FY23 by $8M from the previous midpoint of $1.595-1.62 billion, implying 13-15% constant currency growth, to $1.605-1.625 billion, implying a 14 to 15% constant currency growth. The adj EPS forecast also increased from $6.75 to $6.90 to $6.90 to $7.05.

In light of the general performance of the economy, I would say that EXLS had a successful 2Q23. Revenue and earnings per share surpassed estimates, and the company has raised its outlook. Although one-time gains contributed to overall expansion, both Digital ops management and Analytics showed robust revenue expansion.

Valuation

According to my model, EXLS is valued $181.96 in FY24, representing a 28% increase. My growth assumptions remain the same as my previous model, with FY23 growth of 15% (management guidance) and low-teens growth ahead (which is conservative as I assumed growth to decelerate 300bps from FY23 momentum). My assumptions incorporate my view that the macro environment would see a slow recovery, rather than a sharp recovery.

EXLS is now trading at 18x forward PE, which I believe is not justified as it should trade at its historical average, a large premium to peers. Peers are currently trading in the mid-teens forward PE range, largely due to their slower topline and earnings growth. This is not the case for EXLS; growth remains strong at both levels. In FY24, I projected EXLS to trade at 20x forward PE (its historical average).

Summary

I maintain my buy rating on EXLS due to its strong earnings performance and positive growth prospects. Despite a slight slowdown in Analytics growth, the company's other solutions, such as digital ops management, insurance, and Emerging Business, continue to perform well. Additionally, EXLS's focus on generative AI presents an exciting growth catalyst for the future. Although the stock price dropped, I see this as an opportunity to increase positions, especially considering EXLS's valuation, which appears undervalued compared to its historical average and peers.

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