Capgemini: Competitive Company With Growth Potential And Low Valuation

seekingalpha06-20

The European IT consultant's revenue contracted in key markets.The outlook for 2024 is achievable and includes a return to growth.For what Capgemini offers, the stock is an attractively priced ...

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Jean-Luc Ichard/iStock Editorial via Getty Images Capgemini SE (OTCPK:OTCPK:CAPMF) (OTCPK:OTCPK:CGEMY) is coming off the back of a pretty rough quarter. The usually supportive home markets in Europe (which bring more than 60% of total revenues) have inverted, while North America (30%) has suffered a fresh blow. The setback though looks temporary. The company is healthy and seems likely to return to growth as soon as this year. Hence, the attractively priced stock may not stay that way for long. Q1 2024 Update Revenue in the first quarter ending March came to €5.5b, having contracted 3.3% from a year ago and 1.6% from the previous quarter. The negative growth was widely expected, although the report still came up short of analyst expectations. The management is now convinced that the worst is over.  “As anticipated, the market continued to slow down in Q1, and we confirm the growth trough is now behind us. We expect the market to gradually pick up toward an attractive exit growth rate in Q4, setting up for a more tangible acceleration in 2025.” Aiman Ezzat, Chief Executive Officer, Capgemini Group  Capgemini The biggest declines by region were seen in North America followed by the UK & Ireland, and TTM (Telco, Media & Technology) and Financial Services, by sector. By business, only one out of three, the smallest Strategy & Transformation division, recorded marginally positive growth. Bookings received during the quarter fell by the same percentage as revenue. The book-to-bill ratio, however, came above 1 — as it did in six of the previous eight quarters — indicating continued robust demand, mostly for “high value-added offerings” in Intelligent Industry, Cloud, Data and Artificial Intelligence. The outlook for 2024 remains unchanged: revenue growth of up to 3%, operating margin of around 13% and organic free cash flow of €1.9b. These metrics are roughly on par with last year’s. Financial Health The sputtering top line has not affected Capgemini’s overall financial health. Debt level (net debt €2.0b as of end-2023) has stayed stable over the years, and it helps that there is plenty of operating cash flow (€3.3b) to cover interest payments. Its debt service coverage ratio equals 14 (and anything above 1 is proof of ample coverage). A significant portion of free cash flow is accounted for by capital spending in growth areas. Modest Valuation Given its recent performance, Capgemini is undervalued. At 19x, P/E is the lowest in about three years and also compares favorably to peers such as Accenture (ACN, 25.5x), Infosys (INFY, 23.7x) and Wipro (WIT, 23.4x). Only Cognizant (CTSH) comes cheaper at 15.6x, but that is coupled with lower growth rates. Seeking Alpha Outwitting The Competition Capgemini more than holds its own. It has the largest revenue among two similarly-sized peers, Cognizant and Wipro, and returned the most in the last five years. The company lags behind in profitability; however, a steady growth in revenues has been buttressing earnings.         Key indicators  Capgemini (CGEMY)   Cognizant (CTSH)   Wipro  (WIT)    Market cap US$33.8b US$32.7b US$30.8b   Employees 340,443 344,400 234,000   Revenue TTM  US$24.86b US$12.30b US$10.77b   Revenue per employee US$73,000 US$35,714 US$46,025   EBITDA margin 13.26% 17.73% 18.05%   Net income (3-Yr CAGR) 20.22% 10.99% 0.77%   Price return (5-Yr) 73% 3.28% 27.72%   Click to enlarge Source: Seeking Alpha Strategy wise, Capgemini’s emphasis on iterative contracts and incremental business transformation — through generative AI, among other things — stands in contrast to more ambitious plans of Cognizant and Wipro that are explicitly targeting larger markets and higher-value projects. Path Forward Capgemini may have struggled in recent quarters, as has the industry at large. But that shouldn’t detract from an overwhelmingly positive picture of growth over the past decade. Between 2014 and 2023, revenue registered a compound annual growth rate of 8.7% and earnings of 12.8%. In the same period, operating margin increased from 9% to over 13%, and organic free cash flow more than doubled. Capgemini IT firms foresee a return to more dynamic growth from next year onward, after the end of the current down period. In the meantime, Capgemini is keeping busy, having shifted focus from “non-strategic and discretionary” projects to what’s in demand at the moment, i.e. services delivering operational improvements and cost efficiencies. This augurs well for future growth. For these reasons, I see now as a good time to buy into this high-quality, competitive company with a growth potential.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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