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Neutral Coforge Ltd For Target Rs.4,760

Strong all-round delivery; valuation remains full

Robust FY22 performance priced in

* Coforge Ltd (COFORGE) reported strong organic revenue growth of 7% QoQ CC in 1QFY22, above our estimates of 3% QoQ CC. Including the two months of revenue contribution from SLK, revenue growth stood at 16% QoQ (USD), far higher than our exp. of 10.3% QoQ. Growth was driven by deal ramp-ups in the Americas (+30% QoQ, including the SLK impact). It reported another quarter of strong order intake of USD318m (the highest ever), implying 1.6x book-to-bill. This also included three large deals, with one USD105m deal win.

* The EBITDA margin (pre-RSU) declined 110bps QoQ to 16.1%, weighed by wage hikes, visa costs, and the transition impact from large deals. Strong net additions (1,138 organically) resulted in a drop in utilization by 400bps QoQ.

* While the management increased its FY22 organic revenue growth guidance to at least +19% YoY CC (+200 bps v/s 4QFY22), we expect the company to grow at a much faster pace (c25% YoY CC). The management further mentioned it does not see any headwind to growth and that the guidance is conservative. Given the strong demand tailwind as well as all-time high deal wins and a healthy pipeline, Coforge should continue to grow strongly in FY23 as well.

* The recent SLK Global acquisition is expected to result in faster overall growth, adding +10% in inorganic growth in FY22. We estimate Coforge to deliver consolidated growth of 37% in FY22, leading to an FY21–23E USD revenue CAGR of 29%.

* Coforge is confident of delivering an FY22 EBITDA margin (pre-RSU) of 19%, implying a more than 400bps increase through the course of the year. This would be aided by (a) the deferment of licensing sales (+100bps) to the next quarter, (b) the normalization of utilization levels on ramp-ups in two large deals in 2Q, and (c) the reversal of travel discounts in 4Q. We expect the FY22 EBIT margin to improve 100bp YoY, partially moderated by higher amortization from the SLK acquisition. This should result in a 39.6% PAT CAGR over FY21–23E.

* The stock currently trades at 31x FY23E EPS. This fairly factors in strong growth delivery from Coforge.

* We upgrade our FY22–23E EPS estimates by 10–14%, factoring in the revenue beat during the quarter and increased margins for FY22/FY23E. Our TP of INR4,760/share implies 31x FY23E EPS. Maintain Neutral on fair valuations.

Blockbuster performance on top line; deal wins at all-time highs

* Coforge reported revenue (USD) / adj. EBIT / adj. PAT of 42%/37%/36% YoY v/s our expectation of 36%/38%/37% YoY.

* Revenues grew 16% QoQ to USD199.7m, above our estimate of USD190m (+10.3% QoQ). This includes two months of revenue from the integration of SLK.

* On an organic basis, revenues for the quarter stood at USD185.1m, implying revenue growth of 7.6% QoQ.

* CC organic revenue growth for the quarter came in at 7% QoQ, against our est. of 3% QoQ growth.

* Growth was led by the Americas (+30% QoQ, incl SLK). ROW grew 8.4% QoQ. EMEA saw moderated growth of 2.2% QoQ, after strong growth of 19% QoQ in the previous quarter.

* Growth was broad-based across BFS, Insurance, and Transportation.

* The EBITDA margin (pre-RSU) declined 16.1% – down 110bp QoQ and 40bps below our estimate – weighed by wage hikes and deal ramp-up costs.

* Consequently, adj. PAT at INR1,332m was up 36% YoY, but decreased 3.2% QoQ, in line with our estimates.

* The total order book executable over the next 12 months has expanded 38.7% YoY to USD645m.

* Order intake increased to USD318m on the back of three large deals secured during the quarter, including a large deal of USD105m.

* The company has raised its organic growth guidance to at least 19% YoY CC for FY22, higher than the 17% growth indicated earlier.

* Utilization declined 400bp QoQ, and it added 1,138 employees (+6,962 of SLK).

* Attrition increased to 12.6% (+210bps QoQ).

* Cash and bank balance declined to INR3b, against INR8.4b in the previous quarter, due to payments made toward the SLK acquisition.

* The board has recommended an interim dividend of INR13 per share.

Key highlights from management commentary

* 1QFY22 was a record quarter in terms of composite order intake, executable book, and size and significance of the deals. The spike was attributable to three large deals signed during the quarter. COFORGE signed a USD20m+ contract over three years in the Insurance space and a USD100m contract over four years in the BFS space.

* Furthermore, growth in SLK is expected to exceed the company’s organic growth over the short to medium term.

* Given this momentum, the management has increased its organic revenue guidance to at least 19% YoY CC for FY22.

* The management expects margins to expand substantially over the next three quarters, with 2QFY22 margins coming in higher at 200bps QoQ.

* Continued growth, the reversal of travel discounts, an increase in offshoring, and positive operating leverage should aid margin expansion. Although, these would be partly offset by higher retention and an increase in hiring cost, wage hikes, and a decrease in utilization.

* The management has maintained the margin guidance of achieving 19% preRSU EBITDA margins. RSU costs are expected to have an impact of 85bps on FY22 margins

Valuation and view – fairly priced

* Strong deal wins, a robust deal pipeline, and good consistency in large deal wins (2–3 large deals every quarter) – despite the COVID-led disruption – are encouraging.

* The recent rally in the stock price indicates industry-leading growth and increasing margins, which have already been priced into current valuations. The execution of the company above guidance would be the key to sustaining current multiples.

* We value the company at 31x FY23 EPS. Maintain Neutral on fair valuations.

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