Capgemini: Sound reasons to believe in targets

Fair Value EUR42 vs. EUR39 (+33%)       BUY
News published on October Monday 22, 2012
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After reviewing our medium-term margin estimates, we have raised our DCF-based Fair Value to EUR42 (vs. EUR39), pointing to upside of 33%. In our view, the current share price gives little credit to the group's medium-term operating margin target of 10%. However, we have serious reasons to believe that this target can be reached as of 2015 thanks to Capgemini's global model, which is currently unique in Europe relative to US and Indian players.


ANALYSIS

  • The group's cyclical profile is becoming very questionable. Whereas a lack of recurring sales is often used to justi fy the current share price, we believe an improvement in operating margin to 10% is set to s tem from structural factors : 1) management has pledged vigorous industrialisation out to 2015 with offshore to account for 50%, an "up-or-out" pyramid sys tem for salaries and efforts to cut indi rect cos ts, 2) high-margin proprietary offerings are set to gain momentum.
  • Under-estimated cash generation ability. We believe the Capgemini share has suffe red extensively from the cash accident in H1 2011, which is now well behind us. In the past, Capgemini was long one of the best pupils in this field and we believe that i t can restore free cash flow yield to 5%.
  • Gradual margin improvement. Despi te the sluggish backdrop, Capgemini should be in a position to increase EBIT margin by 0.3 pt in 2012, 0.4 pt in 2013 and 0.7 pt in 2014, particularly on the back of the posi tive impact of restructuring in the Netherlands . We do not expect the departure of CFO Nicolas Dufourcq to undermine this improvement.
  • Adjustments to our forecasts. We are making vi rtually no change to our 2012 sales estimate, whereas we have reduced our estimates for 2013 and 2014 sales by 1% and 2% respectively. We have modified our l fl growth assumptions as follows : +1.4% (vs . +1.6%) for 2012, +2.4% (vs . +2.8%) for 2013, +3.7% (vs . +5%) for 2014. Our EBIT margin estimates remain at 7.9% for 2012 and 8.3% for 2013 whereas we now expect 9% (vs . 8.9%) for 2014. Finally, our adjus ted EPS estimates now s tand at +2% for 2012, -3% for 2013 and +1% for 2014. NB. Our forecas ts take account of a EUR/USD exchange rate of 1.29 vs . 1.27 for 2012 and 1.30 (vs . 1.25) for 2013-14, whereas we are making no change to our EUR/GBP exchange rate of 0.81 for 2012 and 0.80 for 2013.
VALUATION
  • Attractively valued assuming no economic shock. The share is trading on EV/EBIT mul tiples of 5.4x for 2012 and 4.9x for 2013, 30% lower than peers. Whereas the market has played the Atos s tory far more, Capgemini is trading on a discount of 25% relative to the rival group.
  • Our new DCF-derived fai r value of EUR42 (vs . EUR39) is based on mid-term lfl revenue growth of 3% and a mid-term adj. EBIT margin of 10% (vs . 9%).
  • Net cash position on 30th June 2012 was EUR27m (net gearing: -1%)
NEXT CATALYSTS
Q3 2012 sales on 8th November after markets close (conference call at 6pm CET / 5pm BST / 12pm EDT).


Analyst : Gregory Ramirez / 33(0) 1 56 68 75 91 / grami rez@bryangarnier.com

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