TLPFY - Teleperformance: Remains A Buy

2023-07-28 04:57:00 ET

Summary

• Teleperformance's FY revenue organic growth excluding Covid contracts guidance was revised downwards to 7% at midpoint from 9% at midpoint, leading to a 17% decline in share price.
• We are disappointed with the results and management's lack of confidence in the new target.
• We believe at 9x EPS, Teleperformance is cheap and oversold.

A month ago, we presented our note on Teleperformance (TLPFF), highlighting the attractive valuation, solid mid-term fundamentals, and overblown content moderation and AI disintermediation fears, while noting the importance of the Q2 results and full-year guidance to the investment case. Unfortunately, the guidance was revised downwards yet again due to macroeconomic effects, and the share price declined by 17% yesterday, pushing the valuation down to a mere 9x 2023e EPS. We think the derating is excessive and we maintain our Buy rating, albeit with a lower target price that takes into account the challenging environment.

A Spiral Of Trouble

We would suggest our readers to check our previous note on Teleperformance as it provides a detailed overview of the company's recent performance and analyses issues including the content moderation troubles and the following investigation and audits, the weak Q1 results, and full-year guidance downgrade, as well as the challenges and opportunities that arise with the emergence of generative AI.

Weak Q2 And Another Guidance Downgrade

Teleperformance's revenue and adjusted EBITA came in 2-3% below the company-compiled consensus, while margins were largely in line. Organic growth in H1 was 7%, with a meaningful sequential decline, as Q2 organic growth was 230 basis points lower than Q1. The sequential decline can be attributed to tougher comps and a slowdown in the American market especially in the TMT and retail end markets. Organic growth was slightly negative in the North America & APAC segment at -0.2%, while the Specialized Services vertical was the best performing with 17.5% growth.

Most notably full year 2023's organic revenue growth excluding Covid contracts guidance was lowered to 6-8% from 8-10%. FY EBITA margin guidance was reconfirmed at 16.0%, or 50 basis points higher than FY 2022. While we are discouraged by the downgrade, we would like to point out that sell-side analyst consensus was not far off to begin with, as it was already at 8.0% like-for-like excluding Covid contracts growth; that is at the upper end of guidance.

Moreover, while it is disappointing versus expectations, 7% organic growth is not exactly a disaster as it falls within the range of organic growth pre-Covid. At 7% organic revenue growth, combined with 50 basis points of margin expansion, Teleperformance would not have been trading at 9x EPS at any time in the past. There was a significant rise in outsourcing during and after the pandemic and the outsourcing industry is facing tougher comparables as a whole, i.e., a higher base effect, which makes current performance look optically worse. This is substantiated by Concentrix's Q2 results which confirm the same underlying trends. Moreover, having gained significant market share over the last years, Teleperformance faces an even tougher comparison.

What we find problematic however is management's lack of confidence in the guidance, as Deputy CEO Mr. Singh claimed this is a very difficult year to forecast and stated that he doesn't want to sound totally confident. This puts us on the more cautious side, as another guidance downgrade cannot be fully ruled out. That would not only cause another disappointment and a share price decline but also significantly damage credibility. While the worst is likely past us, we would like to have more clarity on this.

Valuation

Teleperformance is now trading at merely 9x 2023e EPS. Its multiple contraction has been steep. Over the last decade, the median forward PE has been around 18x, and over the last 5 years, it has been between 20x and 30x.

While we are disappointed with the guidance downgrade and management's further lack of confidence in the targets, we believe the current valuation is too punitive and doesn't rightly reflect Teleperformance's true value. Teleperformance remains a leading business services company with higher than GDP growth (even now!), high cash generation, high returns on capital, a healthy balance sheet, and significant scope for value creation.

The forecasts and valuation multiples applied in our previous note were already conservative. We do not make any changes to our modeled forecasts. We revise our valuation multiples slightly downwards to reflect a more muted near-term outlook.

Based on a diluted EPS estimate of €15/share in FY 2024, and a forward EPS multiple of 13x we arrive at a target share price of €195, implying 48% upside.

We alternatively use an EV/EBITDA multiple analysis. We maintain our EBITDA forecast of €1.85 billion in FY 2024. Assuming a multiple of 7.5x which is one turn below the target multiple applied in our previous note, and on the very low end of historicals, we arrive at an equity value of €11.3 billion and a target share price of €185.

Our blended valuation gives us a target price of €190 per share or $209 per share. This implies 44% upside. The valuation multiples applied this time are in line with the median of customer experience peers and do not reflect those of higher quality European business services names such as Bureau Veritas (BVRDF), SGS (SGSOF), Rentokil (RTO), etc. that are comparable to Teleperformance, or even Teleperformance's historical multiples.

Risks

Risks include but are not limited to a macroeconomic deterioration, further downward revisions of the FY guidance, disintermediation from generative artificial intelligence, a failed integration of Majorel, value-destructive M&A, negative newsflow around the content moderation business, and a potential "value trap" situation.

Conclusion

Despite our disappointment in the weak Q2 results and the guidance downgrade, we believe at 9x EPS Teleperformance remains a Buy. We believe the derating has been excessive and the risk/reward looks attractive from here.

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