Stock Fundamentals

Why you should book profit in Coforge stock

Hari Viswanath BL Research Bureau | Updated on September 25, 2021

Risk-reward not favourable at current level of ₹5640 for long-term investors

Long-term investors can book profits in the stock of Coforge (formerly known as NIIT Technologies) and deploy the cash in better opportunities in an overheating market, or look to re-enter Coforge at reasonable levels post a correction. The stock trades at next twelve-month (NTM) PE of 45 times (Bloomberg consensus), which is at a significant 140 per cent premium to its five-year average and 80 per cent premium to its two-year average. The risk-reward is no longer favourable in holding on to the stock. It is also trading at a significant premium to Tier 1 IT services companies (TCS, Infosys, Wipro and HCL Tech) whose NTM PEs are in the range of 25-35 times.

Business and performance

Coforge is one of the leading Tier 2 IT services companies with a good track record of execution over the last two decades. The company is differentiated versus peers given its relatively higher exposure to travel/transportation vertical (28 per cent of revenue in FY20). Banking and Financial services (16 per cent), Insurance (30 per cent) are the other major verticals driving its business.

The company managed FY21 well with constant currency revenue growth of 6 per cent (upper end of industry range). A very good performance considering it was a recession year, and also more specifically considering its significant exposure to travel vertical, which was one of the sectors that bore the brunt of the pandemic. Its focus on digital and product engineering segments (52 per cent of revenue – inline with better compared to peers) was a factor that enabled it to deliver decent growth in FY21.

With travel segment too recovering, and digital technologies gaining enhanced traction post pandemic, Coforge is expected to deliver good revenue and earnings growth in FY22 and FY23. Consensus expectations for FY21-23 revenue and EPS growth (which includes some boost from acquisitions) are around 25 and 35 per cent respectively.

Risk reward unfavourable

While growth is good for Coforge, the risk-reward at current levels is not. With the stock up by 145 per cent over the last one year, much of the growth prospects are factored in. Also, it is not clear how the revenue and earnings growth rate will pan out beyond FY23, once benefits of post-covid economic rebound, digitization thrust, boost from acquisitions, etc. start tapering.

In the last 5 years, revenue/EPS CAGR for Coforge was around 11 per cent. According to a NASSCOM report, the Indian IT services sector can reach $300-350 billion in annual revenue by FY25. This implies a 13 per cent CAGR for the industry between FY21-25, implying moderate growth for the industry. Given this, the much higher- than- average growth seen from a post-Covid rebound/digitisation trend, is unlikely to sustain post FY23.

There are a couple of other factors to note too. One, its EBITDA margins are expected at around 17-18 per cent for FY22/23. It is lower than that of Tier 1 IT companies. Companies with lower margins are at higher risk in case of any economic slowdown, currency volatility or intensifying competition. Two, its expected free cash flow (FCF) yield of around 0.6 per cent for FY22 and 2.4 per cent for FY23 are also signals over valuation. Capital returns i.e. dividends or buybacks are usually based on FCF. At the current market price, the dividend yield will not be attractive. Considering above, NTM PE of 45 times appears way beyond comfort zone as it can be justified only if current high growth sustains beyond FY23 and business execution is flawless (there is no guarantee for both). A forward earnings yield (1/PE) of 2.2 per cent for a risk asset in an environment where risk free 10 year government bonds are yielding 6 per cent is not attractive. Hence, cashing in on the gains would be a prudent measure for long-term investors.

Published on September 25, 2021

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