Long-term investors can accumulate the stock of IT products company Oracle Financial Services Software(OFSS). In a low-yield environment, the stock’s current dividend yield of 4.5 per cent is attractive given its history of dividend payment over the last five years, except for FY19 when it paid no dividend to conserve cash. It has a strong balance sheet with net cash at around 9 per cent of market cap and, in the recent years, has been distributing most of its free cash flows as dividends..

The company’s one year forward PE of 19 times and EV/EBITDA of 12 times (Bloomberg consensus), might appear slightly expensive considering expected FY21-23 CAGR for EBITDA and net profit of around 10 per cent. However, this is relatively cheaper than the valuation versus growth prospects of many listed companies in the IT space in India. For example the Tier 1 IT services companies TCS and Infosys trade at a PE of above 30 times and Wipro at 27 times, with FY21-23 earnings CAGR for these companies at round 15 per cent (not entirely comparable given OFSS is a products company).

Another factor to note is the higher operating margins (FY21) for OFSS at around 47 per cent versus that of Tier 1 IT services companies which are in the 20-26 per cent range. Being a products company, OFSS is able to deliver better margins, and this also provides support to its valuation multiple.

Business

OFSS is a global leader in providing IT solutions to the financial services industry. It is majority owned by global software giant Oracle Corporation which holds around a 73 per cent stake. It offers comprehensive banking applications across the spectrum of retail, corporate and investment banking to financial institutions. Its technology solutions cover end-to-end requirements (front to back office) in the financial services industry and also include risk management, analytics and forensic finance.

It is a software products company and earns revenue by way of licencing, consulting and maintenance fees linked to the product. Its flagship product is Oracle Flexcube. The company also earns some revenue from allied services and BPO. However, these currently form a small part with products revenue accounting for 90 per cent of total revenue. It is geographically well-diversified with approximately 33 per cent revenue each coming from North America, EMEA (Europe, Middle East, Africa) and Asia Pacific.

For many competitors, their banking applications that compete with OFSS products form only a part of their business. Infact, even OFSS while independently listed in India, is a unit of Oracle Corporation which has a much diverse portfolio.Companies such as Infosys too have products in this space, but it forms a smaller portion of their overall business. Globally Swiss listed banking software company Temenos can be viewed as a pure-play comparable.

Recent financials

In FY21, OFSS reported revenue of ₹4,983 crore and net profit of ₹1,761 crore, up 2.5 per cent and 20 per cent year on year (Y-o-Y) respectively. On a USD basis, revenue was down by around 1.3 per cent. This can be viewed as a decent performance given the Covid disruption. Competitor Temenos’ revenue was down 8 per cent in USD terms in CY20.

In the recently concluded Q1 (June) of FY22, OFSS reported improving trends with Y-o-Y revenue growth of 4.5 per cent to ₹1,390 crore . Further, the company also reported better than expected improvement in operating margins to a record 50.7 per cent, with operating income up 9 per cent Y-o-Y to ₹708 crore. Trends in deal wins was also strong (up 28 per cent Y-o-Y) and management commentary for the future was positive based on healthy deal wins.

Risks

Few key risks that could impact OFSS performance are its customer concentration and potential disruptions in the industry structure.

Its largest customer accounts for 48 per cent of revenue , and top 10 customers account for around 62 per cent of revenue.

The other potential risk stems from any disruption the SaaS/cloud model can bring to this space. The offtake of SaaS model has been slower in the banking industry due to the complexities and sensitivities involved (data and money). So far, the companies involved in the traditional model have been innovating within the scope available. OFSS too has been investing in cloud and digital technologies and seeing good traction among clients. Long-term investors need to look out for any emerging player/technology that can dent the growth prospects for the existing companies in this space as the SaaS model did to companies in the traditional ERP space. However, there is no immediate threat in this regard.

Overall considering all the above factors, the risk reward appears favorable for OFSS. However, given its recent outperformance (up 27 per cent since May 31) investors can look to accumulate rather than aggressive buying in one go.

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