Ep 1 : A new generation of IT - Newgen Software

Hey guys, Welcome! This is the 1st article on 'The Equity Freak'.

I've been an 'active investor' for the last few years and I'm NOT a trader. NOT into F&O.

I'm the type of guy who binge watches SOIC videos while eating biryani. This is no recommendation to watch SOIC (but I feel that is the best in-depth business analysis channel on the internet right now). Also, I'm NOT a FLTI (Forced Long Term Investor). Well, these are the people who buy into random stock tips from fishy telegram channels and 'Fin-fluencers' and get stuck for the 'long term' without having any idea about what they are doing.

See, the truth is that the stock market is not easy. If it was, everyone would have been a crorepati. Also, giving advice, recommending stocks is like stabbing yourself in the back with SEBI making sure 'free advice' comes with a COST.

So, what does a person with interest in equity analysis do then if he wants to share his knowledge and ideas to the world? He sticks to business analysis ( models and valuations). AND this is the exact reason I've started 'The Equity Freak'. I discuss only businesses which I feel are 'unique/interesting' and warrant an 'in-depth analysis'. NOTHING HERE EVER will be a buy/sell advice because that is a pure waste of time.

So without further adieu, let's begin!

Why did I start off with Newgen?

See, The US FED is going to make its much much much anticipated Rate cut this September (and it's almost certain now). Once that begins , it's expected that more liquidity will flow into the global financial system and with more liquidity around, companies will have more money to spend on projects, new jobs will open, financial organisations will finally start recovering and even BITCOIN might rise to new highs!

Hence, IT would be a beneficiary of this rate cut. And Newgen Software isn't your average IT firm. It's into the fastest growing spaces of Analytics & AI among many other things.

Company Overview

Newgen Software Technologies is a global software Company and is engaged in the business of software product development including designing and delivering end-to-end software solutions covering the entire spectrum of software services from workflow automation to Document management to imaging.

Some of the key snapshots of company include :

The company has developed an indigenous set of solutions and services which position it as a 'Enterprise-wide unified digital transformation platform provider' with capabilities in :

• Contextual Content Services (ECM) :

• Low Code Process Automation (BPM) :

• Omni-channel Customer Engagement (CCM) :

along with growing focus on using Generative AI & Artificial Intelligence Cloud to augment and customise their offerings for their clients. They have categorised this enterprise wide offering as 'NewgenONE' and a detailed capability breakdown of their offerings can be seen below :

Newgen has also developed an indigenous platform for all data science and AI needs called 'Newgen AI Cloud' with a host of cutting edge capabilities in data operations, machine learning and ML operations which it can setup in enterprises.

Thus, any company with the scope of digital transformation integrating low code, data analytics and AI capabilities for certain business functions would be the ideal client for Newgen. With the AI revolution kicking off, the field of growth is huge for the firm.

Coming to the revenue streams of Newgen. 50% of the revenue comes form Support, Implementation and SaaS leading to a strong annuity income of >70% across its various services.

Newgen is heavily reliant on business from clients in the Banking & Financial Services industry which constitute 74% of it's total yearly revenue with 'Insurance & Healthcare','Government' and 'Others' clocking in 14%, 4% and 9% of the rest respectively.

Coming to Geographical diversification of it's client network it is well spaced across major geographies in the world without any such concentration risk.

The company has grown steadily with new client onboarding as this can be seen with the number of clients above Rs 50Mn in billing growing 2.5x in the last 3 financial years.

A brief view on Client concentration is given below indicating a good spread of clients under its active management:

The company also focuses a lot on Research and Development allocating 9~10% of the total revenue towards this. It has a strong culture of filing patents based on latest products/services in growing fields of analytics and AI.

The Company has also been consistently featured by Forrester and Gartner for its various solutions and services and ranked among the best in many of the categories.

Financial Analysis

Newgen is a midcap company growing its topline at a CAGR of 25% approx for the last many years. It also is getting operating leverage given its EBITDA growth rates have been extremely strong at close to 45% YoY when compared to Q1'FY24.

The Operating Profit Margin (OPM) has been steady at close to 23-24 % on annual basis in the last two years indicating ability to retain margins even in an industry facing several headwinds in the last few years.

Over a 3 year period from 2021-2024 some of the important financial metrics is given below:

• Compounded Sales Growth - 23%
• Compounded Profit Growth - 26%
• Rs 1008Cr cash reserves in 2024 vs Rs 564Cr in 2021 (~2x)
• Negligible debt/equity at 0.04%
• Total asset growth ~2x from 800Cr in 2021 to 1500Cr in 2024
• ROCE ~26.6% and ROE ~22.7% indicating strong ability to generate profits form incremental capital employed
• Strong Cash Flow from Operations(CFO) at Rs 264 Cr in Mar'2024

A breakdown of the latest PnL statement is given below:

For further research on Newgen's financials you can refer to Screener.

Latest Management Commentary (Q1'FY25)

The Company in its latest conference call mentioned some important points indicating the firms future growth potential. Some of these include:

• The revenue guidance stood at 20-25% with PAT growth around 20% for FY25
• The company is establishing new clients in growing markets and new product addition along with geographical expansion would be the focus leading to strong topline growth
• New products like Newgen LumYn- a Gen AI-powered hyper-personalization platform designed specifically for the banking sector will help create competitive USP for the firm
• New offices opened in New York and Saudi Arabia along with expansion of sales and marketing team supported by a large network of 300+ channel partners will boost outreach and digital presence
• Expanding partnerships with Global System Integrators, Consulting and Advisory Firms, Technology Partners, Value added resellers and Independent Solution Vendors would be in focus
• 13 new customer logos were added in Q1'FY25 indicating strong client growth momentum
• Solutions in trade, lending, and supply chain finance have been getting good traction and market acceptance, helping businesses grow and manage their operations more efficiently
• Newgen was recognised in Gartner? Market Guide for State and Local Government Grant Management Solutions
• Company has been reaffirmed the short-term rating of CRISIL A1 for its debt instruments
• Some Significant Order Details include: 1. Retail Loan Origination Solution - large Indonesian state bank(Rs 109 Mn), 2. Business Financing Solution - Malaysian government-owned bank (Rs 106 Mn), 3. Digital Account Opening solution - mid-sized commercial and retail bank (Rs 99 Mn), 4. Fintech onboarding solution - Qatar (Rs 98 Mn)

Link to the recording can be accessed here.

Valuation

The best way to evaluate the valuation of Newgen would be by taking a look at its Price to Earnings ratio (P/E). As of 30th Aug 2024, the P/E stands at 58.5 and it can be clearly seen that the stock has undergone a strong P/E re-rating post April 2023 backed by strong EPS growth momentum. On a 5 year P/E basis it is trading at 2.69x premium and form a 3Yr P/E basis its trading at 2.1x premium.

Hence, both from a mid term and long term view the stock looks expensive. But this is because of two reasons:

• Earnings growth momentum rose due to expansion and new products being developed which was higher than past earnings growth
• Also, premium valuation became justified because P/E re-rated to catch up with growing EPS

But the question is : Is the current valuation justified?

For this lets take the help of PEG ratio.The PEG ratio adjusts the traditional P/E ratio by taking into account the growth rate in earnings per share that are expected in the future.

From a PEG perspective, the current P/E is 58.5 and Earnings growth guidance given by management is 20%. Hence, PEG = 58.5/20 = 2.925 ~3 .

As per estimates, value investors normally prefer stocks with PEG less than 1 and Growth investors look at stocks till its about 2-2.5 PEG at the time of entry. GARP (Growth at Reasonable Prices) would be to look at stocks with PEG <=1.5

So as per current guidance, the company might look a little expensive but this is because of the current bull market scenario and the stocks recent re-rating.

One could also look at 1Yr Fwd P/E or 3Yr Fwd P/E and justify their valuations with assumptions.

Technically, the stock has given a 200% return in the last year mostly where P/E re-rating contributed to 60% and EPS growth 40% to the return.

If earnings growth keeps up to the guided level then P/E will sustain and any additional return might come from only EPS growth. Also, with US opening up after the rate cut, we might see higher earnings leading to lowering of the P/E and making the stock more affordable for many different investors.

Final Thoughts

Newgen is delivering strongly. From geographical expansion to new products and services being launched as well as targeting high growth industries like BFS with latest Gen AI offerings the company has a great future ahead if it can deliver on its promises. With high focus on R&D and being ahead of the curve with patents it will be able to protect its USP and "Right to Win" in the market given it manages its employee attrition and stays away from very capital intensive operations. ROIC will be very important to track as additional capital needs to be employed carefully as company scales up quickly.

Overall, its a great company to study. A great company to follow and maybe a great company to work for, if interested in the growing field of Analytics and AI.

Potential interested investors might want to play as per their instinct with this beast!

For further reading on Newgen click here.

Take care guys till we meet next weekend with another banger!

#newgen #business analysis #business model #valuation #ai #IT #equityanalysis