We re-iterate our ‘Buy’ stance on Systems Limited (SYS), one of the largest IT (Information Technology) service exporters in Pakistan with Dec-2023 Target Price of Rs620/share, offering a potential total return of 39% (including dividend yield of 2%).
SYS is a preferred pick due to (i) above average exports growth, (ii) geographical diversification and expansion, (iii) expanding workforce, (iv) cost effective IT resources of Pakistan, (v) foreign currency (FX) based revenues and cost localization, and (vi) recent acquisitions providing inorganic growth.
Outperforming Pakistan’s IT Export Sector: In 9M2022, Pakistan IT exports have increased by 9% YoY to US$1.95bn and have recorded a 5-year (2017-21) CAGR of 23% while export revenue of SYS in 9M2022 increased by 53% YoY in US$ terms and recorded a 5-year (2017-21) CAGR of 27%. Going forward, due to workforce expansion, geographical diversifications, we expect the company to continue to outperform the sector growing at a 5-year (2022-26) CAGR of 25% to reach US$231mn. Market Share of SYS in IT exports is expected to reach near 5% by 2026 from 4.2% expected in 2022.
Geographical diversification and expansion in new regions: Geographical diversification & expansion will remain key revenue driver for SYS. Revenue contribution from Middle East, North America, Pakistan and Europe in 9M2022 constituted 42%, 34%, 18% and 5%, respectively. Middle East segment would be main driver of growth due to economic boom, digitization of economies and business consolidation in Saudi Arabia, Qatar and Egypt. The company is also venturing into new regions such as Singapore and South Africa.
Higher contribution from expanding workforce: SYS has added 750 employees during 9M2022 taking total employees to 6,024. During the last 5-years (2017-21), average employees have grown at CAGR of 18%. Going forward, we expect workforce to grow at a 5-year (2021-26) CAGR of 20% due to rising demand which will remain key revenue and earning driver for the company.
Cost effective IT resources of Pakistan & opportunities for SYS: According to Glassdoor – an American based employer review company, average monthly package (including bonuses) for senior software developer in Pakistan is ~US$1,500. This is in comparison to renumeration in India (~US$ 2,000), Philippines (~US$2300), China (~US$ 5,500) etc. SYS leverages this opportunity with monthly compensation per employee at ~US$1,000, significantly lower than other countries.
Foreign Currency revenue versus localized costs driving margins: In 9M2022, company had ~85% revenue in foreign currencies (US$, EURO). This is in contrast to 76% cost of sales in PKR term and the rest in US$. This is because ~94% of workforce is located in Pakistan. Company has utilized cost efficient labor and optimized other direct costs as well as admin expenses. Therefore, GP Margin/EBITDA Margin/Net Margins in 9M2022 is rising and is at 32%/29%/25% vs. 5-year avg. of 31%/24%/21%.
Recent acquisitions providing inorganic growth: SYS acquired Ndc Tech (Ndc) and Treehouse Consulting (THC) at start of 3Q2022. Ndc acquisition is to gain expertise in core banking and cross sell existing digital services to financial sector globally. These clients are usually high value and ensure long term recurring revenue. THC has been merged into the Middle East subsidiary of SYS and has synergies since it provides similar services as the new parent. The acquisitions are likely to contribute around 10% to the total revenue and around 5-10% to the bottom-line of the company in 2023.
Valuations: SYS warrants premium valuations as the company is set to post 5-year (2022-26) revenue CAGR of 37% (24% in US$ terms) and earning CAGR of 31% (19% in US$ terms). SYS is currently trading at 2023E and 2024F PE of 15.4x and 12.1x, respectively. This compares favorably to regional peer companies with comparable PE of ~23x. It also trades at 2023 and 2024 PS of 3.1x and 2.4x compared to regional peer companies PS of 5x.
Risks: Key risk to our investment thesis include (i) higher than expected slowdown in global IT spending, (ii) high employee turnover, (iii) acquisitions not providing expected synergies, (iv) taxation regime becoming in-line with other sectors, (v) PKR appreciation and (vi) unavailability of skilled labor.
Courtesy- Topline Securities