CAPMF - Capgemini Revenue Stable But Clients Delay Discretionary Projects

2023-08-07 19:16:47 ET

Summary

• Capgemini SE reported growth in revenue and EPS in H1 2023 financial results.
• Clients are delaying discretionary projects due to macroeconomic uncertainty.
• I'm Neutral [Hold] on Capgemini SE stock for the near term.

A Quick Take On Capgemini SE

Capgemini SE (CAPMF, CGEMY ) reported its H1 2023 financial results on July 28, 2023, growing revenue and EPS year-over-year.

The firm provides a wide range of IT consulting and outsourcing services to organizations worldwide.

Capgemini SE clients are delaying their discretionary projects due to macroeconomic uncertainty, which is common among consulting companies now.

I'm therefore Neutral [Hold] on CGEMY in the near term.

Capgemini Overview And Market

Paris, France-based Capgemini was founded in 1967 to provide strategy, advisory, IT consulting and digital transformation services to customers across all major industry verticals.

The firm is headed by Chief Executive Officer Mr. Aiman Ezzat, who was appointed to his position in May 2020 while joining the firm originally in 2005. He previously was Managing Director of International Operations at Headstrong, a business and technology consultancy.

The company's primary offerings include the following:

• Consulting.

• Digital transformation.

• Engineering services.

• Managed services.

• Creative design.

• Business process outsourcing.

• Transactional services.

• Maintenance services.

The firm acquires customers through its direct sales and marketing efforts as well as through partner referrals and online/offline marketing efforts.

According to a 2021 market research report by 360 Market Updates, the global market for digital transformation strategy consulting was an estimated $58.2 billion in 2019 and is forecast to reach $143 billion by 2025.

This represents a forecast CAGR of 16.2% from 2020 to 2025.

The main drivers for this expected growth are a large transition from on-premises, legacy systems to cloud-based environments with complex architectures.

Also, the COVID-19 pandemic has likely pulled forward significant demand to modernize enterprise systems resulting in increased growth prospects for digital transformation consultancies.

Major competitive or other industry participants include:

• Globant.

• EPAM.

• Slalom.

• Accenture.

• Deloitte Digital.

• McKinsey.

• Thoughtworks.

• BCG.

• IDEO.

• Cognizant Technology Solutions.

• Company in-house development efforts.

Capgemini's Recent Financial Trends

• Total revenue by quarter has continued to rise, as has operating income, as the chart shows below:

• Gross profit margin by quarter has flatlined in recent quarters; Selling, G&A expenses as a percentage of total revenue by quarter have varied slightly with a narrow range.

• Earnings per share (Diluted) have trended somewhat higher in the last several quarters.

(All data in the above charts is IFRS).

In the past 12 months, CGEMY's stock price has fallen 6.75% vs. the rise of the SPDR S&P Software & Services ETF ( XSW ) of 4.76%, as the chart indicates below:

For the balance sheet , the firm ended the quarter with $3.5 billion in cash and equivalents and $7.65 billion in total debt, of which $1.46 billion was categorized as the current portion due within 12 months.

Over the trailing twelve months, free cash flow was an impressive $2.1 billion, during which capital expenditures were $295.7 million. The company paid $193.1 million in stock-based compensation in the last four quarters, the highest trailing twelve-month result in the last eleven quarters.

Valuation And Other Metrics For Capgemini

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha)

Below is an estimated DCF (Discounted Cash Flow) analysis of the firm's projected growth and earnings:

Assuming generous DCF parameters, the firm's shares would be valued at approximately $37.38 versus the current price of $35.73, indicating they are potentially currently fully valued, with the given earnings, growth, and discount rate assumptions of the DCF.

As a reference, a relevant partial public comparable would be Cognizant Technology Solutions Corporation (CTSH); shown below is a comparison of their primary valuation metrics:

(Source - Seeking Alpha)

Commentary On Capgemini

In its last earnings call ( Source - Seeking Alpha ), covering H1 2023's results, management highlighted the "soft" economic environment with 2023 "shaping up along the gradual deceleration scenario we expected for the year."

As with other consulting companies, management is seeing clients delay their discretionary projects quarter by quarter, resulting in lower revenue recognition than hoped for.

The company's employee attrition rate dropped to 1% year-over-year and employee utilization rate "is trending up since Q2," with offshore leverage reaching "58% at the end of June."

Total revenue for Q2 2023 rose 11.4% year-over-year and gross profit margin had no change.

Selling, G&A expenses as a percentage of revenue dropped by 0.2% YoY and operating profit increased by 15%.

The company's financial position is moderate, with plenty of liquidity but a high amount of total debt and $1.46 billion due in the near term and likely subject to higher interest rates.

Looking ahead, consensus revenue estimates for 2023 are $24.999 billion, or annual growth of 6.9%.

If achieved, this would represent a slight increase in revenue growth versus 2022's growth rate of 6.67% over 2021, indicating a stable growth trajectory.

From management's most recent earnings call, I prepared a chart showing the frequency of key terms mentioned (or not) in the call, as shown below:

I'm most interested in the frequency of potentially negative terms, so management or analyst questions cited "Challeng[es][ing]" four times, "Macro" once and "Drop" two times.

Management believes that a return to more normal client activity after the next two quarters, or starting in 2024.

Regarding valuation, my discounted cash flow calculation suggests the stock may be fully valued at around $37.00.

Since macroeconomic risks are currently elevated, I'm Neutral [Hold] on CGEMY for the near term.

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