Investors with a medium-term perspective can consider an exposure in the Aztecsoft stock. We are upgrading our `hold' recommendation made in early September to a `buy' based on our bullish view on the core business of outsourced product development (OPD) and testing market.
The robust second quarter performance, along with strong client additions after a disappointing first quarter, has improved the financial picture.
However, this stock will be appropriate only for investors willing to look beyond the next two quarters (December 2006 and March 2007), as there may be some turbulence in the stock linked to two factors: One, Dendrite International Inc, one of the large customers of Aztec contributing 10 per cent of revenues, has exercised the option of acquiring the offshore development centre in Bangalore built and operated by Aztec.
The transfer to Dendrite will be effective January 1, 2007, which will be reflected in Aztec's financials in the fourth quarter of 2006-07. Two, the impact of rupee appreciation and aggressive employee addition in the latest quarter lowering utilisation in this specialised activity may affect financials in the short run. As the medium-term picture remains robust, we recommend that investors accumulate the stock on any weakness linked to these events.
At the current market price, the stock trades at a price-earnings multiple of 16 times its likely per-share earnings for 2006-07. In the OPD space, companies operate with early-stage outfits backed by venture capital funding; any slowdown in technology or venture capital funding can affect its financials.
Robust second quarter
After the disappointing performance in the first quarter of 2006-07, the company has bounced back with a strong 14.2 per cent sequential growth in consolidated revenues and 23.6 per cent growth in post-tax earnings. While the operating profit margin improved by over two percentage points to 23 per cent, the net profit margin also perked up by one percentage point to 17 per cent. Aztec's operating margin is relatively higher than some of its mid-cap peers on account of its higher offshore contribution (at 85 per cent) and lower operating expenses.
Client addition has been quite strong in recent quarters. The company has added 13 clients in the second quarter taking the total active client count to 83. And the latest additions include established wireless players and ones from the software as a service domain. After expanding its set of offerings in the OPD space, Aztec recently entered two new technology segments: Wireless and networking technologies, and embedded and device technologies. Apart from this, over the past year, the company has also been making investments in newer technology services such as Web 2.0 and Software as a service, broadbasing its overall client list.
It was also a quarter in which Aztec made a significant ramp-up in the employee count, adding 525 employees vis-à-vis 113 added in the first quarter.
A chunk of its revenues (53 per cent) continues to accrue from the top five clients. And this remains a cause for concern in the medium term.
If the demand environment remains strong over the next year, Aztec is likely to reap the benefits of billing rate upsides in its existing client accounts. As the company is also actively scouting for acquisitions, any specialised small-size acquisition at reasonable valuation may prove to be a positive trigger for the stock.