Analyst Corner: Maintain buy on Newgen with lower target price of Rs 650

In our recent meeting, Newgen Software’s CEO and CFO highlighted that the Middle East and APAC regions are doing well but the US is lagging due to high employee attrition at clients, which is delaying decision-making. Revenues from System-Integrator (SI)-led engagements are also being delayed. For FY23, the management expects 20% revenue growth and a year-on-year (YoY) margin contraction.

We lower our estimate by 2-3% and expect Newgen to deliver an 18% earnings CAGR in FY22-24. We maintain buy with a lower target price of Rs 650.

West Asia & APAC regions driving growth; the US lagging: Newgen has benefited from the rise in oil prices, which has boosted growth in West Asia (+43% YoY over 9MFY22), particularly for new license sales. This is likely to continue in FY23 given the sharp rise in oil prices. The company has also seen a pick-up in growth in the APAC region (21% YoY in 9MFY22), led by a scale-up of its presence in these markets. However, Newgen’s growth in the US and India has stalled, with revenues being flat over 9MFY22. In our recent meeting, the CEO and CFO highlighted that high employee attrition, possibly due to the Great Resignation, is affecting the pace with which new initiatives are being taken up among clients in the US. This may impact new license sales in the US.

Growth for FY23 to be in line with pre-pandemic levels: Newgen’s trailing 12-month new logo wins have fallen from the pre-pandemic level, mainly due to curbs over international travel. The company expects revenue growth of 20% in FY23 which is largely in line with pre-pandemic levels.

Rising margin pressures: Over 9MFY22, Newgen’s employee costs have increased by 27% YoY from a depressed base. Given the sharp rise in attrition levels across the industry, we see employee cost escalation remaining high in FY23.

Furthermore, travel costs are likely to rise sharply in FY23. The company’s margins in FY23 might be lower than in FY22.
We lower our FY23 revenue growth assumptions from 22% to 20% given the delays in the scale-up of SI-related revenue streams. We also tweak our employee cost estimates to factor in higher wage inflation in FY23, which leads to a 2-3% cut to our FY23-24 earnings estimates. Over FY22-24, we now expect Newgen to deliver an 18% EPS CAGR. We also lower our target valuations from 24x to 20x as we normalise our longer-term growth expectations and lower our target price (TP) to Rs 650. A stronger scale-up of SI-related revenue streams will be key to the further potential upside.