CINT - CI&T Continues Geographic Diversification Efforts As AI Demand Beckons

2023-05-31 16:03:23 ET

Summary

• CI&T reported its Q1 2023 financial results on May 19, 2023, beating both revenue and EPS consensus estimates.
• The firm provides a range of technology and digital transformation consulting services to businesses in Latin America, the U.S. and Europe.
• CINT continues to seek geographic diversification but it is still early days and operating costs in the U.S. and Europe are materially higher.
• I'm on Hold for CINT for the near term as its diversification efforts and foreign currency exposure are still risky.

A Quick Take On CI&T

CI&T ( CINT ) reported its Q1 2023 financial results on May 19, 2023, beating both revenue and EPS consensus estimates.

The firm provides digital transformation software consulting services primarily to clients in Latin America.

I previously wrote about CINT with a Hold outlook here .

While its diversification efforts into the US and Europe could mitigate the negative impact of the Brazilian Real’s drop in relative value, this will take time to materialize.

As such, I remain on Hold for CINT in the near term, as its foreign diversification efforts are still in early stages.

CI&T Overview

Campinas, Brazil-based CI&T was founded to develop a range of software services to assist businesses in their digital transformation efforts.

Management is headed by co-founder and Chief Executive Officer Cesar Gon, who has been with the firm since its inception and previously earned a master's degree in computer science from UNICAMP.

The company’s primary offerings include:

• Strategy

• Design

• Engineering

The firm pursues clients across all industry verticals, but focuses its primary efforts on the industries of:

• Retail and Commerce

• Financial Services

• Technology

• Automotive

• Consumer Packaged Goods

The company has distributed teams in Brazil, the U.S. UK, Canada, Japan, China, Portugal and Australia.

CI&T’s Market & Competition

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:

• Endava (DAVA)

• Globant (GLOB)

• EPAM Systems (EPAM)

• Accenture (ACN)

• Capgemini (CAPMF)

• Cognizant Technology Solutions (CTSH)

• Tata Consultancy

• Ideo

• McKinsey & Company

• The Omnicom Group

• Sapient

• WPP (WPP)

• Others

CINT’s Recent Financial Trends

• Total revenue by quarter has grown per the following chart:

• Gross profit margin by quarter has produced no discernible trend:

• Selling, G&A expenses as a percentage of total revenue by quarter have fluctuated as follows:

• Operating income by quarter has trended higher recently, albeit unevenly:

• Operating leverage by quarter has varied with no clear pattern or trend:

• Earnings per share (Diluted) have remained positive, as the chart shows below:

(All data in the above charts is GAAP)

In the past 12 months, CINT’s stock price has fallen 66.8% vs. that of the SPDR S&P Software & Services ETF’s ( XSW ) rise of 3.49%, as the chart indicates below:

For the balance sheet, the firm ended the quarter with $68.2 million in cash, equivalents and short-term investments and $187.1 million in total debt, of which $46.1 million was categorized as short-term borrowings or the current portion due within 12 months.

Over the trailing twelve months, free cash flow was a solid $37.0 million, of which capital expenditures accounted for only $2.8 million. The company paid just $1.9 million in stock-based compensation in the last four quarters.

Valuation And Other Metrics For CI&T

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 $5.80 versus the current price of $4.82, indicating they are potentially currently undervalued, with the given earnings, growth, and discount rate assumptions of the DCF.

Commentary On CI&T

In its last earnings call (Source - Seeking Alpha), covering Q1 2023’s results, management highlighted the role of AI in its service offerings as clients increasingly demand more incorporation of AI in their services.

However, on the all-important employee side for a consulting business, leadership continues to accept normal employee attrition levels as it seeks to ‘adapt to the current demand environment.’

The firm has recently begun executing on its strategy to expand its footprint in both Europe and the U.S., two regions with tremendous wealth but also higher labor costs.

The benefit of this strategy is that it allows the firm to diversify its geographic footprint but will take time to bear fruit, with additional operating costs in the meantime.

Management said the company’s net revenue retention rate ‘over the past five years has been around 123%’ but did not give a more recent performance figure in this regard.

Total revenue for Q1 2023 rose 16.6% year-over-year and gross profit margin was unchanged.

Selling, G&A expenses as a percentage of revenue fell by 0.7 percentage points and operating income increased by 23.9% year-over-year.

Looking ahead, management guided full-year 2022 revenue to grow at 15% year-over-year at the midpoint of the range and on a constant currency basis.

Adjusted EBITDA margin is expected to be ‘at least 19%’ for 2023.

The company's financial position is reasonably strong, although it has a fair amount of debt maturing in the next twelve months; its net debt-to-EBITDA multiple is a reasonable 1.5x.

Regarding valuation, my discounted cash flow analysis suggests that the stock is somewhat undervalued at its current price.

The primary risk to the company’s outlook is the uncertain macroeconomic environment for its technology- and media-related clients.

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 ‘Uncertain’ two times and ‘Macro’ two times also.

The negative terms refer to the uncertain macro environment the firm’s clients are operating in, resulting in greater revenue growth uncertainty for the company.

A complicating factor to the company’s outlook is the uncertainty surrounding the Brazilian Real’s poor performance against the US Dollar.

The Real is down 6.9% in the past twelve months, as shown below:

The long-term trend for the Real against the US Dollar is also negative, acting as a headwind to CI&T to the extent that it is exposed to non-dollar revenue.

While its diversification efforts into the US and Europe could mitigate the negative impact of the Brazilian Real’s drop in relative value, this will take time to materialize.

As such, I remain on Hold for CINT in the near term, as its foreign diversification efforts are still in early stages.

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