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Cash flows will be the key going ahead

While revenue growth reported by Coforge for Q1FY22 was ahead of our estimates, margins were behind. EBIT margin contracted 220bps QoQ largely due to salary hikes, utilisation dip, visa and acquisition costs. Sequential increase in receivables approximated the increase in overall revenues. Management attributed this to SLK Global acquisition and some delays in recoveries. Useful lives of intangibles (10 years) arising out of SLK seem a bit stretched (v/s industry practice) leading to higher than our earlier expected earnings trajectory. For context, TCS / Infosys amortize customer related intangible assets over 3-7 years.

Order intake (US$318mn vs US$201mn in Mar-21) was strong with skew towards EMEA. Company hinted at organic growth of 19%+ (CC, vs 17%+ earlier) for FY22. Consensus (including us, 22%) is already ahead of this. Pre-RSU EBITDA margin guidance of 19% was retained. While we like Coforge for its differentiated competitive positioning in certain niche areas (e.g. insurance, TTH), expensive valuation (38x FY23E EPS v/s ~30x of TCS/LTI and 42x FY23E OCF v/s 27-28x of TCS/LTI) is the key rationale behind our REDUCE rating.

* Revenue beat; margin miss; sharp increase in receivables. On organic basis, revenues grew ahead of our estimates at 7% QoQ (CC). Including two months of inorganic contribution from SLK Global, revenues increased 16% QoQ (USD). Growth across top-5 and top-10 accounts was strong. Across geographies, sequentially, Europe (+3.2% QoQ) remained tepid while organic growth in the Americas and RoW was strong. Organic growth across key verticals was broad based.

Sequentially, EBIT margin contracted 220bps to 11.5%. This was 60bps behind our estimate of 12.1%. Salary revisions, sharp drop in utilisations (from 81% to 77%), visa costs and one-time acquisition-related expenses were the key margin headwinds during the quarter. Receivables increased by Rs2bn QoQ, largely in line with the overall incremental revenues the company generated during Jun-21.

Management indicated this increase was led by consolidation of SLK Global and delays in recovery from a few Indian clients. Coforge completed the provisional purchase price allocation for SLK Global. Tangible assets of SLK were valued at ~Rs2bn. Intangible assets and goodwill on consolidation were valued at Rs3bn / Rs6bn respectively.

* Strong outlook priced into expensive valuations. Order intake during Jun-21 (US$318mn vs US$201mn in Mar-21) was strong with sharp skew towards EMEA. Company hinted at organic growth of 19%+ (CC, vs 17%+ earlier) for FY22. Consensus (including us) is already ahead of this guidance. Pre-RSU EBITDA margin guidance of 19% was retained. While we like the company for its differentiated competitive positioning in certain niche areas (e.g. insurance, TTH), expensive valuation (38x FY23E EPS) is the key rationale behind our REDUCE rating.

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