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Incremental growth hinges on travel

As anticipated, Newgen reported flat revenues in 9MFY21 with significant margin improvement (from 8.1% in 9MFY20 to 23.4% in 9MFY21). US/APAC quarterly revenues grew 26%/15% YoY with the company reporting 11 new logo wins. Newgen continues to invest aggressively across R&D, S&M and senior leadership personnel with expenses aggregating to ~23% of revenues in Q3. Company hinted at improving demand environment across key industry segments. However, we believe mid-teen growth expectation for FY22E is contingent upon travel opening up and deal conversions happening in Q4FY21E and Q1FY22E. Further, we see a risk of potential margin contraction by ~550bps in FY22E as some of the reined-in costs return (e.g. wage hikes, lower utilisations, S&M investments, travel, etc.). Post a ~40% rally over the previous three months (vs 23% on Nifty IT), we downgrade the stock to ADD (from Buy) given: 1) volatility in deal closures, and 2) dependence on travel to acquire new logos.

* Revenues in line with a meaningful margin surprise. Overall revenues remained flat at 0.7% YoY in Q3FY21 with annuity-based revenues declining 3% due to change in mix of support revenues from onsite to offshore. Margins surprised on the positive side with margins expanding to 23.4% in 9MFY21 from 8.1% in 9MFY20 primarily due to savings in employee costs, lower travel expenses and lower provisioning in Q3. As management alluded to improved deal wins and continuation of cost-saving measures in Q4, we now expect FY21E revenue growth to be at ~1.5% with margins at 25.5% (earlier 20%).

* Downgrade to ADD: Newgen’s strong presence and positioning (rated well by industry advisors) in the high-growth markets of BPM and low-code application development should boost earnings going forward. In addition to client mining, a meaningful part of growth comes from acquiring new customers (~15% of revenues came from new clients in FY18-FY20). Typically, new logo acquisitions require sales and delivery to travel to client location for deal conversion. As the Covid-induced lockdown remains a key risk, deal closures might get delayed if freeze in travel continues. New deal wins will be key for further rerating in our opinion. Considering the aforementioned risks and ~40% return in past three months, we downgrade the stock to ADD.

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