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Strong all round delivery, valuations steep

Robust FY22 performance priced in

* COFORGE reported an organic revenue growth of 3.9% QoQ CC in 2QFY22. Including the one-month incremental contribution from SLK Global, revenue growth stood in line at 6.6% QoQ (USD). Growth was driven by deal rampups in the Americas (+30% QoQ, including the impact from SLK Global). It reported an order intake of USD285m (-10% QoQ/+42% YoY), implying a book-to-bill ratio of 1.3x. This also included three large deals.

* EBITDA margin (pre-RSU) increased by 250bp QoQ to 18.6% (est: 18.2%), led by large deal ramp ups, higher offshoring and utilization, and pyramid rationalization.

* While the management increased its FY22 organic revenue growth guidance to at least 22% YoY CC (+300bp from 1QFY22 levels), we expect it to grow at a much faster pace (~27.5% YoY). The management sees materially sequential growth in 2HFY22. SLK Global’s performance is expected to be better than anticipated, with the management guiding at least 22% YoY CC in FY22 (est. 25%). We expect COFORGE to deliver a consolidated growth of 38% YoY in FY22E.

* Given the strong demand tailwind, solid deal wins, and healthy pipeline, COFORGE should continue its strong performance in FY23E as well, leading to a USD revenue CAGR of 30% (25% organic CAGR) over FY21-23E.

* The management is confident of delivering an FY22 EBITDA margin (pre-RSU) of 19%, with an over 100bp sequential expansion in 3Q, followed by a further expansion in 4QFY22. Margin expansion will be aided by offshore traction and pyramid rationalization, led by large deal ramp ups, which are more offshore centric. Sale of software licenses in 3QFY22 would also add to margin expansion. We expect FY22 EBIT margin to improve by 130bp YoY. This should result in 40% PAT CAGR over FY21-23E.

* The stock currently trades at 33.5x FY23E EPS and factors in a strong growth delivery.

* Our FY23E PAT estimate remains unchanged, led by a slight revenue and margin upgrade, offset by a higher minority interest impact from SLK Global. Our TP of INR5,440/share implies 36x FY23E EPS. We maintain our Neutral rating on fair valuations.

In line revenue, better margin despite a PAT miss

* COFORGE reported a revenue (USD)/adjusted EBIT/adjusted PAT of 38%/38%/26% YoY (est. 38%/34%/40%).

* Revenue grew 16% QoQ to USD212.8m, in line with our estimate of USD213m (+6.6% QoQ). This includes one month of revenue from the integration of SLK Global.

* On an organic basis, revenue stood at USD190.6m in 2QFY22, implying a revenue growth of 3% QoQ. In CC terms, organic revenue growth in 2QFY22 stood at 3.9% QoQ.

* SD revenue/INR EBIT/INR PAT grew by 40%/39%/32% in 1HFY22.

* Growth was led by Americas (+7.4% QoQ), including SLK Global. RoW grew by 22.1% QoQ. EMEA saw a 3.3% QoQ decline.

* Growth was broad based across verticals, with BFS and Transportation driving growth, while Insurance was a tad lower.

* EBITDA margin (pre-RSU) rose 250bp QoQ to 18.6%, but was 40bp below our estimate.

* Adjusted PAT grew 26% YoY and 11.6% QoQ to INR1,519m, but was below our estimate led by negative other income and higher minority interest.

* Total order book executable over the next 12 months rose 7% QoQ and 41% YoY to USD688m.

* Order intake grew 42% YoY (-10% QoQ) to USD318m on the back of three large deals secured in 2QFY22.

* The management has raised its organic growth guidance to at least 22% YoY CC for FY22, which is higher than the 19% growth indicated earlier.

* Utilization increased by 150bp QoQ. It added 295 employees in 2QFY22.

* Attrition increased to 15.3% (+270bp QoQ).

* Cash and bank balances stood flat at INR3b.

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

Key highlights from the management commentary

* Order intake, excluding SLK Global, stood at USD285m in 2QFY22. Executable order book, excluding/including SLK Global, stood at USD603m/USD688m.

* The management does not see early signs of a moderation in demand and expects robust sequential growth in 2HFY22. It expects tailwinds in 3Q from the booking of license revenue from AdvantageGo, which got deferred from 2QFY22. SLK Global’s performance is expected to be better than anticipated.

* Given this momentum, the management has increased its organic revenue guidance to at least 22% (v/s 19% YoY CC) for FY22. SLK Global is expected to grow at least 22% YoY CC in FY22. On a consolidated basis, COFORGE is expected to grow by at least 35% YoY CC.

* The management expects margin tailwinds to continue and sees at least 100bp QoQ expansion in margin in 3QFY22 (despite it being a seasonally weak quarter). 4Q would further witness a sequential margin expansion over 3QFY22. The management has retained its adjusted EBITDA margin guidance of 19% for FY22.

* The Insurance vertical and EMEA geography were soft in 2QFY22. The management expects them to bounce back smartly in 2HFY22.

* The company will materially increase its fresher intake and expects to onboard 1.5k freshers in FY22, which is 6x higher than its FY20 fresher intake.

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) is encouraging.

* The recent rally in the stock indicates industry-leading growth and increasing margin, which have already been priced into current valuations. 

* We value COFORGE at 36x FY23 EPS and maintain our Neutral rating on fair valuations.

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