Home >Markets >Mark To Market >Coforge needs its margins to rebound to justify shares’ premium valuations

A key trend in the recent earnings performance of Indian IT companies has been that of a stellar improvement in margins. However, Coforge Ltd, formerly NIIT Technologies Ltd, has been an exception.

Analysts said the subdued trend in the company’s margins is to be blamed for its comparatively lower stock returns.

In the last one year, the Coforge stock has rallied around 63% and is currently trading at 2,729 on the NSE. In the same time, share prices of peers such as Mindtree Ltd and Mphasis Ltd have doubled.

Margin pressure
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Margin pressure

“We note that among our tier II IT services coverage, all mid-tier techs, barring Coforge, reported 10-1300 basis points (bps) year-on-year (y-o-y) improvement in Ebit margins (in Q3). This has been cited by some investors as the primary reason for the relative underperformance for the company," JM Financial Institutional Securities Ltd said in a report on 25 February.

Ebit is short for earnings before interest, tax and depreciation. One basis point is one hundredth of a percentage point.

The growth in margins for other IT service providers was aided by cost savings and a significant increase in percentage of offshore revenues.

In the December quarter, Corforge saw Ebit margins decline by 90bps y-o-y. On a nine-month basis, its margins were flat. Coforge’s margins were impacted by higher exposure to the travel segment and its retention plan for senior management. Despite these factors, the company’s management expects around 20 bps y-o-y improvement in margins in FY21.

Despite lacklustre margin growth, the Coforge stock trades at a premium to some competitors. Bloomberg data shows that the stock is trading at a one-year forward price-to-earnings (PE) of 26 times. This is higher than the 23 times and 21 times valuation multiples of Mindtree and Mphasis, respectively.

“There are some positives such as its strong deal win pipeline which aids revenue visibility, but that has largely been factored in," said an analyst with a domestic brokerage house, who did not want to be named.

Coforge won two large deals in the December quarter. One deal was in the insurance segment worth $45 million and another deal was its new segment of healthcare worth $20 million.

The company’s management told analysts that its 12-month executable order book stood at $501 million, up 18%.

“Valuations seem to be stretched in the backdrop of the miss in operating margins. Not just compared to peers, valuations are much higher than the stock’s long-term average of around 15 times price-to-earnings multiple. Execution of orders and improvement in margins are key for valuations," added the analyst.

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