Coforge Ltd stock has delivered mouth-watering returns to its investors in a matter of months. On Monday, the tier-2 IT services stock hit a new 52-week high of ₹9,354. With that, the stock price has more than doubled from its 52-week low of ₹4,287 in May 2024.
The Street is finding comfort from a combination of favourable factors. For instance, Coforge management recently told analysts at Nirmal Bang Institutional Equities that deal closures in the December quarter (Q3FY25) remained better than expected at the start of the quarter. The December quarter is seasonally weak for the IT sector owing to furloughs, which usually lead to fewer deal wins/conversions and thus weaker sequential revenue growth.
The Nirmal Bang report dated 12 December further highlighted that there was strong show of confidence from chief financial officer Saurabh Goel’s commentary on achieving $2 billion revenue by FY27. Coforge’s current revenue run-rate is around $1.5 billion.
After all, Coforge performance in the September quarter (Q2FY25) was impressive as it managed to deliver sequential organic constant-currency revenue growth of 5.5%, beating analysts’ expectations. Revenue growth was broad-based across verticals and geographies.
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It should be noted that there have been lingering concerns surrounding the pace of Coforge’s organic growth and revenue synergy from the Cigniti acquisition. Against this backdrop, the Q2FY25 result boosted investor sentiment. Further, fresh order intake in Q2FY25 stood at $516 million (including $67 million from Cigniti), making it the 10th consecutive quarter of more than $300 million order intake. The executable order book over the next 12 months, at $1,305 million, was up more than 40% year-on-year. The company signed three large deals during the quarter, one each in continental Europe, North America and the United Kingdom.
Margin pain
So far so good, but margin remains a sore point. In Q2FY25, Ebitda margin contracted sequentially to 15.8%, hurt by wage hikes (effective July) and acquisition-related expenses. Ebitda is earnings before interest, tax, depreciation and amortisation.
Moreover, Coforge’s new employee stock options (Esop) scheme, introduced in Q3FY25, may add to the near-term margin pain. An incremental headwind of 120 basis points (bps) is likely for Coforge in Q3FY25, management said in the Q2FY25 earnings call. One basis point is 0.01%. In Q1FY26, the old Esop scheme will end, and that will lead to a tailwind of 60 bps, management added. But for now, further margin compression may be a dampener.
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Research firm HSBC Securities and Capital Markets (India) recently downgraded Coforge stock from ‘buy’ to ‘hold’. Coforge is in the middle of integrating with Cigniti and is likely to benefit from merger & acquisition synergies. However, after the sharp run-up, any integration or business risks are not factored into the stock price, said the HSBC report on 9 December. This could translate to a potential downside risk for the company’s growth and margin in FY25-27. Note that the Cigniti acquisition will help Coforge expand in North America, add more Fortune 500 clients, and enable cross-selling of its services.
Coforge has significant exposure to the banking, financial services and insurance (BFSI) vertical, which is showing green shoots of recovery, and that should aid revenue growth visibility. But delayed synergy benefits could overshadow the other positives and weigh on the stock’s performance. Coforge has outpaced the Nifty IT index with nearly 50% returns so far in calendar year 2024. In effect, valuations have become expensive. The stock trades at 46 times estimated FY26 earnings, a premium to its large-cap peers, showed Bloomberg data.
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