Sidoti Initiates Coverage Of Virtusa, Notes Revenue Growth Rate Will Retreat

In a report published Tuesday, Sidoti & Company analyst Jairam Nathan initiated coverage of Virtusa Corporation (NASDAQ: VRTU) with a Neutral rating and $50 price target as management can do a better job in monetizing its clients.

According to Nathan, Virtusa delivered a 23 percent compounded annual revenue growth rate which "validates" its platform approach and domain expertise in customer-facing applications. The company's "platform" approach utilizes customers' existing IT infrastructure and leverages open source tools. As such, the company reduces execution risk and offers continuous improvements.

Nathan said that Virtusa's "above industry-average" profit growth reflects its expanded customer base, as demonstrated by a decline in revenue contribution from its top 10 clients from 70 percent in fiscal 2010 to 52 percent today. However, the analyst noted that the company's average revenue per client is up 57 percent since 2010, but is still only half the rate of its peers. In addition, the company can still better penetrate its clients beyond the 10 largest.

Looking forward, the analyst sees several catalysts including the need for greater compliance and risk management requirements at banking clients and healthcare regulations at insurance clients, in addition to the ongoing shift to cloud-based infrastructure management.

Despite the various catalysts ahead, Nathan argued that Virtusa needs to carry out acquisitions to improve its competitive position against larger peers. Although management considers acquisitions the primary use of cash, the analyst is forecasting cash per share will grow to $10.52 in fiscal 2017 from $7.00 after putting $34 million toward its acquisition of Apparatus.

Bottom line, over the past two years, the stock's average multiple expanded to 21x from 15x to "outstrip" the 17x forward EPS average since its 2007 IPO. The analyst's $50 price target is based on a multiple of 20x (in-line with the peer group average) of his fiscal 2017 operating EPS estimate of $2.15 plus cash per share of $7.00.