Why you should book profit in Route Mobile stock

Investors with low risk appetite can consider booking profits in the shares of Route Mobile after a 500 percent upside from its IPO price of ₹350 in September 2020. Post its stellar run the stock is now valued at a rich 64 times FY22 EPS (Bloomberg consensus) and 50 times FY23 EPS. Even on the basis of EV/Sales which is also a useful metric to value software companies, it trades at a multiple of 6.4 times its FY22 sales. This is also not cheap considering its margins are low with FY22 gross margins expected at around 21 per cent and EBIT margin expected at around 11-12 per cent.

Besides if one has to do some relative analysis within the tech sector in the Indian investment universe, bellwether TCS (which is also expensive) trades at 6.3 times EV/Sales (FY22) with substantially higher margins - gross margin expected at around 42 per cent and EBIT margin at around 26 per cent.This is notwithstanding the fact that Route Mobile is not entirely comparable with Indian IT services companies given differences in business model.

Amongst other factors, companies with better margins usually deserve premium valuation because they are better positioned to withstand dowturns. The other factor to consider is growth. Broadly based on current valuation, it does appear Route Mobile is already getting premium valuation for its growth prospects, and much of the positives are baked in at current levels. Given valuation, potential competitive threats from larger industry players and no significant technology moat in a low margin environment, cashing in on the gains may be a prudent thing to do.

This apart, signs of froth in stock can also be evinced from recent irrational movements. On Friday (July 2), the stock went up by 20 per cent, increasing its market cap by a good ₹2,000 crore on a mere ₹30 crore acquisition announced. Such share price movements defy fundamental logic.While some global peers of Route Mobile – US listed Twilio and Europe listed Sinch also trade at expensive levels (24 times and 6.5 times EV/Sales, respectively), overvaluation of one stock cannot be used to justify valuation in another stock. There are pockets of US markets that are extremely frothy and Twilio appears to be one of those. It also needs to be noted that Twilio and Sinch are much bigger in size and seeing better growth over the next 2 years – CY20 to 22 revenue CAGR expected at 38 and 47 per cent respectively versus FY21-23 revenue CAGR for Route Mobile expected at 22 per cent.

Business

Route Mobile provides cloud-communication platform as a service (CPaaS) to enterprises, over the top players (OTT), and mobile network operators. This enables cost effective communication solutions that combine voice, messaging and data communication services over networks of telecom operators. Some of the consumer facing use cases for cloud communication services used by enterprises are features like one time passwords or OTPs sent/received while making online transactions, transaction confirmations and delivery update messages for e-commerce transactions, message updates related to flight schedules to passengers, etc.

The company primarily makes its revenue by enabling these different kind of messaging services for customers and bills them based on the number of such messages or transactions. While this business is a bit commoditised, it is also developing solutions to move up the value chain and expand offerings to customers. It was recently in the news for announcing a technology partnership with TrueCaller. Progress on these fronts over next few quarters and the impact it has on financials needs to be tracked.

The Covid induced acceleration in digitization trends was a key structural positive for the company, and it has done well to capitalize and build upon it. Besides this being reflected in better than expected financial performance in FY21, few core operating metrics like number of large clients, growth in recurring revenue (client stickiness) showed improvement y-o-y. One point of concern though is higher client concentration with top ten clients accounting for 59 per cent of revenue in FY21. It generates significant part of its business from overseas clients with over 80 per cent of revenue from exports in recent years.

Financials

The company has delivered revenue growth of around 47 per cent year on year (y-o-y) and adjusted PAT up 84 per cent in FY21. While this is impressive, the growth rate will temper going forward with consensus expecting around 29 per cent revenue and 39 per cent EPS growth for FY22.

Cash conversion for FY21 was good with cash flow from operations/ EBITDA at 131 per cent. The company has a good balance sheet with no debt.

From an investor perspective, the company performance has not given much to complain. The point to ponder upon is whether the stock has already captured the recent operating performance and expectations for the future.