WNS - WNS: Leveraging Existing Knowledge With AI

2023-07-25 10:14:33 ET

Summary

• WNS Holdings reported strong Q1 results, beating estimates with revenue growth and the addition of 6 new customers. Despite this, the company's share price hit a 52-week low due to market concerns about the impact of large language models on the BPO industry.
• The company's balance sheet is solid, with manageable debt and a conservative guidance for adjusted net income for FY24. WNS has also made strategic acquisitions to enhance its AI capabilities and is recognized for its competitive advantages in the industry.
• Despite market concerns about the impact of AI, WNS management seems to see AI as an opportunity.

Thesis

WNS Holdings (WNS) is in an interesting situation right now. The high interest and rapid development in the artificial intelligence industry could make the BPO industry obsolete in the future, or it could help them leverage their knowledge. Therefore, the most important factor for WNS will be whether they can increase their competitive advantage or lose it.

At this point it is hard to tell how this will play out, but I have faith in the WNS management team and think they will become stronger with the help of AI, but if things change in the future I have no problem getting out of WNS if I think my thesis is broken.

WNS Holdings Q1 Results

WNS had what I thought was a really strong result, beating the conservative estimates, as they almost always do . Revenues, excluding repair payments, grew 15.5% year-over-year and the company added 6 new customers and expanded 36 existing relationships in a challenging environment. But the company's success contrasts with its share price, which hit a new 52-week low a few days ago. Double-digit growth but a 52-week low is an odd situation for a company that was only somewhat expensive with a P/E in the thirties.

Part of this is clearly due to the multiple pullback WNS has had, but I think also because the market believes that the large language models such as ChatGPT will have a negative impact on the BPO industry. However, I think this is more of an opportunity as WNS can clearly use LLMs to leverage their expertise and data.

I believe WNS also sees this as an opportunity to deliver solutions and has raised its guidance slightly. Right now, WNS does not look like it is slowing down, and over the long term their results have been fantastic, with revenue growing 10% per year over the last 5 years and EBIT growing as much as 14% per year over the same period.

WNS Balance Sheet

WNS's balance sheet is rock solid with only $206.2m in debt and $242.6m in cash + investments, plus they had a GAAP profit of $137.3m in FY2023 and therefore have a debt/profit ratio of ~1.5x.

And the guidance for adjusted net income for FY24 is $211 million to $223 million, which is conservative as always for WNS, so I don't see much risk in their balance sheet. Debt can be easily serviced, and therefore the downside in this category is protected in my view.

Capital Allocation

Normally I like it when companies buy back shares, but they have to do it at reasonable prices, but WNS bought back 1.1 million shares at an average price of $77.84, where I think they could have used that capital more efficiently because they bought back at a high price. They spent $85.6 million on it, which is a lot for a company like WNS.

Also, there's not much to see from the buybacks, as most of them were just to combat share dilution. Besides, I really hope they buy back more shares now that the stock price is depressed, because that is when shareholders get the most value out of it.

WNS has repurchased 9.9 million shares since 2015 at an average price of $50.47, but the share count has only been reduced by ~3 million shares. But this is likely complaining on a high level as most companies growing like WNS these days have far more problems with their SBC and shares outstanding. But it's something to keep an eye on and see how this develops in the future and if they buy back more shares now at the low prices.

Acquisitions are also a big part of WNS' capital allocation, and here t hey bought Smart Cube , with its digital AI platform Amplifi Pro, and OptiBuy, which is in the consulting and implementation solutions industry. Both acquisitions fit with WNS and are designed to add value in the current environment where AI is becoming increasingly important.

Competitive Advantages

In recent months, WNS has once again been recognized as a leader in the Finance & Accounting BPO and BPO Consulting Services industry , which shows its strength. In addition, after a while, they become mission-critical to their customers because they gather all the knowledge and data to know how to run operations efficiently. And also, I think they're going to be able to leverage their data even more with AI because they have very industry-specific data and knowledge. Right now, they have 5,000 people working with AI and another 1,000 in training. So they are investing in the future, and generative AI could be a growth driver for them through more consulting work.

That could lead to better margins going forward and also more sticky revenue as they indicated in the last earnings call. In general, management sees AI as an opportunity, not a threat. However, the market seems to currently have a different view and sees AI as bad for BPM companies.

Due to being mission-critical for their customers, after a while their switching costs are really high for their customers, which benefits WNS tremendously. So, in my opinion, the combination of high switching costs and knowledge is a powerful combination that should help WNS to have a good position in their industry. The knowledge they have about different industries and business processes also acts as a barrier to entry today, but this barrier and knowledge could become more valuable or less valuable depending on how the whole AI situation develops in the coming years.

Their high ROIC also shows that they have some sort of competitive advantage, and due to their low debt they also have a low WACC, which results in a very nice ROIC-WACC spread. I see their WACC between 7% and 8%, which would result in a spread of about 8%-9%. So if they can find enough opportunities to invest money at that spread, they will definitely create value for shareholders, and because of the growth opportunities in their industry, I think there will be many choices. However, the market will be very competitive with many different players.

WNS has also had a 20%+ ROE for some time without being overleveraged, and these tend to be truly outstanding companies, which are quite rare. So WNS is clearly a high quality company in a difficult market where there is some uncertainty about how the LLMs will affect that market and the companies in it. This could be one of those cases where a quality company can be bought at a discount because of temporary circumstances. However, it could also be that the market is right and BPO companies will be hit hard and lose market share in the future.

Valuation

Due to the drop in share price, WNS is as cheap as it has been in the last year. An EV / EBIT of 18x is not cheap for a traditional value investor, but considering the growth rate, I think this is a fair price for a wonderful company.

Risks

The biggest risk is that AI would completely destroy the future prospects of WNS and the other players in the BPO industry, and there is a chance that this could happen. However, as I said earlier, I think the WNS management team knows what they are doing, and therefore I think they can use the technology to their advantage.

Other risks include a sharp rise in wages in India, which would erase the competitive advantage they currently enjoy from lower labor costs.

Conclusion

For now, I remain bullish on WNS as they managed to grow significantly year-over-year and even slightly raised their guidance for FY24. This combined with the rock solid balance sheet makes me stay with this company for now until I get information that would negatively impact my thesis. If they can improve margins through the use of AI, get more recurring revenue, and maybe even strengthen their competitive position, it could be a phenomenal long-term investment. The higher than expected revenues in the first quarter and the new major customer are positive signs for the future.

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