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In a sweet spot

Coforge’s 3Q performance (3.7% CC QoQ growth; flat margins) moderated a tad more than expected largely due to seasonal factors. Raised FY23E revenue (+22% in CC terms; up from 20% earlier) and reiteration of margin guidance despite a steep ask for 4Q (+210bps QoQ) indicate 3Q softness is transitory. Sustained deal wins (USD 345mn TCV) suggest Coforge’s sales engine is working well even as spends shift from discretionary to efficiency driven programs. Coforge and PSYS’ 3Q deal wins allay fears that mid-cap IT could lose out in a vendor consolidation scenario, lending credence to sustained growth out-performance thesis. Besides, Coforge’s 12-M executable order book (+20% YoY) places it well to drive an industry leading growth in FY24 as well. We forecast 17% USD revenue and 30% EPS CAGR over FY23-25E, highest in our coverage universe. We therefore believe that Coforge’s PER multiples, while +0.5x SD above 5-year median, could sustain. We value the stock at 21x forward EPS, 10% discount to our target multiple for PSYS/INFO, to arrive at TP of INR 4,790. We assume coverage with a BUY rating.

* 3QFY23: transitory slowdown: 3QFY23 CC QoQ growth of 3.7% was the lowest in past eight quarters as softness in mortgage processing business, furloughs in BFS and higher hedge losses impacted growth. Further, higher SG&A expenses (+120bps QoQ) resulted in flat EBITDA margins. While the growth and margin missed consensus estimates, management raised its FY23 revenue guidance from at least 20% to 22% CC growth implying 4Q CC QoQ growth of 3.3%. More importantly, management is confident of achieving its adj. EBITDA guidance of 18.5-19% for FY23, implying a healthy 210bps QoQ expansion in 4Q. Pyramid correction, improved utilisation, absence of furloughs and some moderation in SG&A levels are some of the levers cited to achieve the same.

* Improved visibility getting in to FY24: The company won deals worth USD 345mn TCV including five large deals (USD 20mn+). Deal wins had a healthy mix of cost take-out and vendor consolidation deals, allaying fears that tier-II IT Services vendors could lose out in a vendor consolidation scenario. Executable order book over the next-12 months also improved by 20% YoY to USD 840mn. Coforge has historically (average of FY18-22) delivered 1.3-1.7x (average 1.5) of its year end executable order book over NTM. Even an average revenue conversion ratio of 1.5x of current order book implies 25% YoY growth for FY24, materially above our current estimate of 16.4% USD revenue growth. Though we believe TCV to revenue conversion could slow due to longer tenure cost takeout deals, we still see sufficient buffer to achieve our estimates

Valuation should sustain; assume coverage with BUY: Coforge is trading at +0.5x SD above 5-year median PER (10% discount to PSYS). Coforge’s strong revenue visibility, structurally improved margin profile (higher offshore, low exposure to emerging markets) and exposure to resilient verticals (Transportation, BFS) lends strong support to earnings trajectory. We estimate 17% USD revenue and 30% EPS CAGR over FY23-25E – highest in our coverage universe. We value the stock at 21x forward multiple, at 10% discount to our target multiple to PSYS/INFO to arrive at our TP of INR 4,790. Our TP implies an upside of 17%. We assume coverage with a BUY rating.

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