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Retaining FY24 guidance implies a strong 4Q exit

Reiterate Neutral due to full valuations

* Coforge (COFORGE) reported 3QFY24 revenue growth of 1.8% QoQ in CC terms, above our estimates. Reported revenue stood at USD282.0m (up 1.4% QoQ/12.0% YoY). The growth was driven by BFS with 3.3% QoQ growth, while the other two verticals – TTH and Insurance – were weak, declining 2.4% and 1.3% QoQ, respectively.

* The company reported a robust order intake of USD354m in 3QFY24 with three large deals (1 NN+ 2 Renewals). These took the overall deals signed in 9MFY24 to USD1.2b (BTB of 1.4x), and resulted in a robust 12-month executable order book of USD974m (+16.8% YoY). However, given the extreme furlough impact in 3QFY24, management now expects FY24 USD CC revenue growth to be at the lower range of the guidance range (13-16% YoY).

* While management reiterated its view that the overall macro demand outlook remains tight, with the CY24 budget likely to remain stable vs. the previous year, the company continues to gain wallet share. This has been evident in their retaining guidance, which we saw as a potential risk due to the increased furloughs during 3Q. With guidance retained at 13%-16% YoY in CC, we expect the company to be a little ahead of its lower band. This should also help them generate a tailwind heading into FY25. We expect COFORGE to deliver a revenue CAGR of 12.4% for FY23-26.

* Further, despite the 3Q EBITDA margin missing our estimates slightly due to furloughs, management was very confident of delivering significant margin improvement in 4QFY24 (+150-200bp QoQ), which should help them exit the year at ~20% EBITDA margin (ahead of the profile a year ago). Management also highlighted the view that the FY25 EBITDA margin will be up YoY. We continue to see this as achievable propelled by multiple tailwinds. We have raised our FY25/FY26 EPS estimates by 1-3% to factor in the 3Q results. This would lead to a 19.2% INR PAT CAGR over FY23-26E.

* We, however, believe that the robust outlook is already factored into the price, and we do not see any potential upside from here. Our TP of INR6,600 implies 30x FY26E EPS. We reiterate our NEUTRAL rating on fair valuations.

Performance mixed; guidance maintained

* COFORGE posted USD revenue growth of 1.8% QoQ in CC, against our estimates of 0.7% CC. Reported USD growth was 1.4% QoQ.

* Growth was fueled by BFS (+3.3% QoQ), while TTH and Insurance reported a decline of 2.4% and 1.3% QoQ, respectively.

* There was a strong order intake of USD354m (+13% QoQ); further, the 12M executable orders rose 16% YoY to USD974m. COFORGE signed three large deals during the quarter.

* EBITDA margin (pre-RSU) stood at 18.0%, up 40bp QoQ vs. our estimate of 18.5% for the quarter. 23 January 2024 3QFY24 Result Update | Sector: Technology Coforge 23 January 2024 32

* Utilization dropped 60bp QoQ to 79.4%; net employee addition was muted and attrition dipped 90bp QoQ to 12.1%.

* Adj PAT was at INR2.4b (+31.6% QoQ) vs. our expectations of INR2.7b. The miss was due to lower other income during 3QFY24.

* FY24 revenue guidance was maintained in the range of 13-16% YoY CC, while adjusted EBITDA (Pre-RSU) would be at similar level as FY23.

* The Board declared a dividend of INR19 per share.

Key highlights from the management commentary

* The demand environment continues to be challenging, with clients evaluating their budgets. The IT budgets are likely to be flat or improve slightly over CY23. However, the budget might have a positive bias in the latter half of the year once the macro challenges recede.

* The third quarter had an extreme furlough impact, which hit the TTH and Insurance verticals. The top-10 clients are banking-heavy accounts, where the furlough impact has been higher than anticipated.

* Given the extreme furlough impact in 3QFY24, and pain within the ex-BFS vertical, the fourth quarter requires a significant heavy lifting to reach the middle or upper-end of the guidance band. Management was comfortable delivering FY24 growth at the lower end of the guidance band of 13-16%.

* The margin is expected to see a sharp improvement of 150-200bp in 4Q, partly driven by the reversal of furlough impact. The third quarter had a furlough impact of 40-50bp on margin.

Valuation and view: Guidance maintained; but valuations remain full

* We expect the large deal ramp-ups and healthy funnel to support its growth despite the near-term challenges. These would help the company achieve its FY24 revenue guidance.

* Strong execution, robust client mining, and continued investment in S&M have helped the company gain wallet share and deliver industry-leading growth.

* However, we believe that the robust outlook is already factored into the price and we do not see any potential upside from here on. Our TP of INR6,600 implies 30x FY26E EPS. We reiterate our NEUTRAL rating on fair valuations.

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