Genpact (G) presents a rare opportunity in this market to make strong returns while keeping the comfort of valuation, growth and business model. In addition to the valuation discount, the lack of understanding of growth could lead to near triple-digit returns.
Business model
Genpact is a professional services firm offering business process outsourcing (NYSE:BPO) and IT services. The company competes with the likes of Accenture, Infosys, Cognizant and Wipro, among others. In the wake of the pandemic, Genpact has been focusing on the shift from offline to online, virtualization of technology services delivery, accelerated consumption of cloud-based services, increased growth in real-time predictive analytics and the move towards human-centred design for better user experience.
The company classifies its revenue across three verticals: Banking, Capital Markets and Insurance, or BCMI, Consumer Goods, Retail, Life Sciences and Healthcare, or CGRLH, and High Tech, Manufacturing and Services, or HMS.
Source: Company filings, Author analysis
Genpact also has a sizeable chunk of its revenue coming from GE (GE) or its parent company, from which Genpact was spun out in the late 1990s.
Source: Company filings
GE has been Genpact’s largest client since inception and accounted for 13.6% of Genpact’s 2019 revenue. Genpact’s revenue has been quite concentrated.
Source: Company filings
Despite reasonable growth, the revenue concentration is possibly one of the reasons for the company’s valuation discount to its peers.
However, the last nine months have led to a significant change in market dynamics, which can lead to a potential re-rating of the stock.
Investment thesis
Workforce transition to remote working: When the pandemic struck, there was a scamper to balance the need to get employees on remote locations and manage the size of the workforce while ensuring client delivery was impacted to a minimum. Since March, not only has Genpact adjusted to the reality of the day, but also the clients have become used to work happening in remote locations. Going forward, there are two scenarios:
- We get hit by a second wave: In the worst case, the remote working set-up has already been established, and thus the level of surprise versus what was witnessed in March would be much lesser. In particular, the banking clients have also accepted the new norms and approvals from them may not take as long.
- Things begin to normalize: 90% of Genpact’s workforce is operating remotely. Client expectations of work happening on-site are unlikely to be a step function. Instead, we expect a return to on-site to be a calibrated ramp due to reasons of safety and cost.
In either scenario, we expect the mix shift to remain in favor of remote for the next couple of years, benefitting the company’s margins.
High utilization and travel costs are likely to remain a tailwind to the margins: Owing to people working for longer hours and cost reductions, Genpact has seen healthy utilization levels.
Source: The Economist
The half an hour increase in India augurs well for Genpact, given a large part of its labor pool is in India. While the sustained demand in areas such as analytics has allowed for even greater efficiencies, the time saved in travelling to the office and overall savings in international travel costs are also likely to continue help enhance margins. It is worth mentioning that a large component of the SG&A cost used to be travel-related and in the wake of the restrictions, much of those dollars are again likely to flow down to the operating level.
‘As-a-service’: To fight commoditization and the associated evils, Genpact has been investing in delivering many of its services as subscription solutions. The BPO services are likely to benefit significantly from all such automation given clients have been demanding higher-value work. The solution-based bundling of services also allows remote workers to deepen their skill sets, which is a significant tactical benefit that can keep the workforce engaged since they cannot be in the physical proximity of others.
Relationship with GE: While Genpact has been reducing its reliance on GE, GE continues to be the company’s single largest customer. We think the planning reduction in revenue from GE bodes well for the company given the increase in diversification of the client base that this move will bring about for Genpact. We note that while GE revenue grew 78% in 2019, for 9M19, the revenue from GE was flat. While part of the reason was the pandemic, the reduction in the spend from GE was offset by incremental work awarded.
Financials
We look at the consensus revenue estimates for Genpact.
Source: Seeking Alpha
While the consensus expects revenue growth to be sub 5% for 2020, the management expects to grow between 5-5.5%
Looking at the performance of the segments historically, we find that the CGRLH (Consumer Goods, Retail, Life Sciences and Healthcare) and HMS (High Tech, Manufacturing and Services) were doing better than the BCMI (Banking, Capital Markets and Insurance) vertical.
Source: Company filings, Author analysis
Given the defensive nature of clients served in CGRLH, we find natural for this segment to recover faster than the others. Considering the growing need for forecasting and the associated analytics, we think not only CGRLH but also HMS could see reasonable growth. While some of this growth could come from the pent-up demand during the pandemic, the structural tailwinds should not be ignored.
We expect 2021 to witness a complete recovery in demand, with 2022 as a more growth-friendly year.
Valuation
As mentioned earlier, Genpact trades at a discount to its peers. On average, the P/S of this group is closer to 3.67x versus 2.11x for Genpact. Applying the average multiple to the 2021 expected revenue of $4.1 billion, we arrive at a market cap of a little over $15 billion. Compared to the current market cap of $7.7 billion, we expect almost a doubling of the stock price.
Risks
The key risk to our thesis is from BPO services provided by Genpact becoming obsolete faster than the company can replace them with automation and ‘as-a-service’ offerings. The risk gets amplified because of the numerous small players/freelancers who are more nimble and agile versus a large organization such as Genpact and the clients’ willingness to outsource pieces of work to the gig economy workers. The saving grace is that such small players cannot compete with Genpact when it comes to more sophisticated clients, where years of relationships and brands are possibly still more critical.
Conclusion
Genpact looks reasonably poised to recover and come out stronger from the pandemic. In addition to having become battle-tested, the efficiencies built to comfort the margins in the absence of pricing strength are likely to help cashflows. Considering the recovery in core markets, the focus on automation and support from GE we think Genpact represents an overlooked opportunity to potentially double one’s money.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.