March 21, 2023
1. Summary
IT engineering company, Germany
Capitalizes for 1,225 million (Small Cap)
Current market price €90 per share
High organic growth (15% - 20% per year) + M&A (Mergers and acquisitions)
Insiders own 35% of the shares, they are aligned with the shareholders
Attractive valuation, 15x PER and 9x EV/EBITDA
87% of revenues are recurring
It grows at rates of 30% per year
Low capex, business with low reinvestment
High growth sector
Allgeier spin-off
2. Company
Nagarro is a global digital engineering company, with more than 18,000 employees, present in 33 countries, mainly in central Europe and North America. It was listed on the Frankfurt stock exchange in October 2020 as a result of the Allgeier spin-off. Allgeier's decision to separate its units was basically to highlight the quality of this division and provide services to medium and large companies, with a global focus.
The company provides engineering and digital technology solutions for business transformation, serving companies with old processes that need to be renewed. It includes digital product engineering, e-commerce and customer experience services, solutions based on AI (artificial intelligence) and ML (machine learning), cloud solutions and IoT (internet of things), and consulting on the next generation, it also offers process agility; API (application programming interface) management; application development and management; service management application; artificial intelligence, data and analytics, blockchain, CRM, digital commerce solutions, digital marketing, internet of things, security services, process transformation and modernization.
2.1 Business lines
The company is mainly focused on the financial, automotive and retail sectors.
A positive aspect is that it has little concentration of clients, it doesn´t depend on a few important clients that if they fail, can make the company fail.
74% of sales come from various clients, the company is not concentrated in a few clients.
2.2 Geographic positioning
Most of its clients are in Europe and North America, countries with stronger currencies and more stable economies.
The North America segment grew 30% between 2020 and 2021, Central Europe 13% and the Rest of Europe segment 21% in the same period.
And the engineers who work for Nagarro are in countries like India, Romania, countries with equally skilled labor, but at a lower cost. (Offshore model)
The workforce is almost 90% professional engineers.
2.3 Growth
Sales grow at rates of 32% CAGR in recent years and a growth of 57% in 2022. A growth of 20% is forecast for 2023
The company has more than 1,000 customers in 63 countries
The growth strategy is basically organic (with existing clients and new ones recommended) and M&A (mergers and acquisitions)
20% organic growth, of which 7% comes from new customers and 13% from existing customers.
Regarding M&A, the company completed the acquisition of RipeConcepts in 2022, a leading digital services company (adds 10 million in sales and 650 employees), and an important merger agreement with Techmill, a fintech services company, partner of Temenos, leader world in financial technology for banking. In 2023 the company has completed the acquisition of Infocore and is awaiting antitrust approval for the acquisition of MBIS, a SAP Gold Partner in Turkey.
Sales
2.4 EBITDA evolution of the company
EBITDA grows at a rate of 40% per year, higher than sales due to the expansion of the company's margins.
It has gone from 26 M to 148 M in the last 5 years.
In Europe, the market where they operate grows 10%, in North America 10%, globally 12% (GDP grows 4%), the IT engineering sector grows well above world GDP.
Traditional IT services grow only 3%.
2.5 The company works with the leaders of each sector
For Nagarro's clients (or similar companies such as Epam or Globant) the investment doesno´t end, because when they have developed something, appears new thing (if a competing company does it, you also have to do it and you must call companies like Nagarro that do that development to catch up with new functionality that appears) non stop update.
2.6 Workforce
Nagarro has more than 18,000 employees located in 33 countries.
It operates under the Offshore model with engineers in low-cost regions, such as India, Eastern Europe, reducing personnel costs.
They then have engineers locally to coordinate the project
Code-based work can be done remotely from other regions
This cost advantage allows them to offer lower prices to the customer, beating the competition, thanks to better profit margins.
It has only 13% staff turnover, low turnover compared to the market average of 20% (workers remain with the company longer, on average 7 years, compared to the industry average of 4 years)
It is important to highlight, in companies in this sector, that the cost of personnel (staff cost) is high, as it is the engine of the business. In the case of Nagarro it corresponds to 68% of sales.
2.7 Shareholder structure
54% of the shares are available for trading on the stock market (free float) and 31% of the shares correspond to the company's administrative committee. A high percentage of free float to carry out a fluid purchase and sale transaction by shareholders.
3. IT services sector
Within the IT services sector, there are three categories. It is important to understand each of them to define the positive characteristics of the specific sector where Nagarro operates.
3.1 IT Categories
Global IT services: It basically consists of implementation, they take certain software and install it to the client. These types of companies are the ones that deliver less value to the customer. They grow on average at 1%~4% per year.
Offshore IT services: Computer consulting that adds a little more value to the chain, subcontracts jobs in countries like India with lower salaries to develop basic workload tasks, and in turn, makes these companies have better costs, which They pass on to their customers at better prices. These companies grow on average at 14% per year.
Next~gen or IT Engineering: consists of solutions tailored to the client, they can create their own software and adapt them to the client's needs. They can also use standard software from Microsoft, Oracle, Salesforce and adapted to customer needs, obtaining high EBITDA margins (between 15% and 20%). These types of companies have offshore or local engineers and grow on average at 33% per year. Growth of more than 15%~20% per year is expected for the next 5 years. Nagarro operates in this category of IT services.
February 2020 study, since then these multiples have been compressed making these companies even more attractive
3.2 Global overview of the sector
The IT digital services market is projected to exceed $500 trillion by 2024, growing 12% per year over four years, well above many industries and well above global GDP. Other studies estimate a market of more than 700 billion by 2024 with growth of 15% per year. No doubt that Nagarro has a tailwind to continue its growth.
4. Spin-off between Allgeier and Nagarro October 2020
Nagarro is the result of an Allgeier Spin-off (A Spin-off is a company that is born from another, through the separation of a subsidiary division or department, to become a company by itself)
Nagarro begins trading in October 2020 after the spin-off
1:1 distribution ratio (1 Nagarro share for every Allgeier share)
The idea was to improve visibility to Nagarro
By going public, the company has access to market capital for its potential growth.
Allgeier is focused on the German market by language and Nagarro with a more international profile
The original management team stayed after the spin off which was a good indicator
5. Comparables
When comparing Nagarro with other similar companies in the sector, we see that it has lower average P/FCF and EV/EBITDA multiples (it is the cheapest because it has less capitalization and is less known).
It has a ROCE of 30%, higher than its peers (efficient asset management)
Its closest competitors are Endava, Globant and Epam, they have similar growth, similar operating margins, but a higher valuation, due to their liquidity and capitalization.
Nagarro has some debt, only 0.9x debt/ebitda, something normal in the initial phase
Endava plc and Epam use the Offshore model with engineers from Eastern Europe.
Globant uses engineers from Latin America.
6. Management
The management team has a low remuneration, fixed salaries close to €300,000, extremely low for a directive in this sector. It is clear that his interest is in the revaluation of the shares.
The founders of Nagarro own more than 30% of the company's shares. They are completely aligned with investors.
7. Competitive advantages
Specialization (correct engineers template)
Reputation and low costs
Recurring (integration of experience with old clients, applied to new ones)
Management team
growth platform
8. Risks
Related to the general economy and market conditions
Concentration and rotation of some consumers
Associated with acquisitions that the company may make
Credit risk, customer default on service payments
cyber attacks
9. Valuation
For the valuation we are going to assume three scenarios, 1. conservative, 2. optimistic and 3. pessimistic, to estimate the different situations that may occur.
The company comes from growing at 57% in the last years, but in no scenario will I put a growth higher than 23%, assuming that it is difficult to maintain such high levels of growth over time
The company's historical average valuation is around PER 30x and EV/EBITDA 15x (it is currently at more depressed multiples due to the current banking crisis and the conflict in Ukraine, directly affecting small and micro technology caps in Europe)
The company is listed (market cap) for €1,225 million at a price of €90 per share, with 13 million shares.
9.1 Conservative scenario
I assume a growth in sales of 20%
Operating margin (EBIT) of 10%
25% tax rate
Valuation multiples of 25x PER and 13x EV/EBITDA
Current trading price of €90 per share.
In this escenario, the estimated return would be around 30% per year over five years. *
Target price could be around €240 over three years and €350 over five years.
9.2 Optimistic scenario
Assumed growth of 23%, with M&A (mergers and acquisitions)
We maintain operating margins of 12%
30x PER and 16x EV/EBITDA multiple expansion
Current prices of €90 per share.
Estimated return would be around 40% per year over five years. *
Target price could be around €350 over three years and €500 over five years.
9.3 Pessimistic scenario
Growth slows to 15%, could be the scene of a recession
Compress margins to 8%
PER 18x and EV/EBITDA of 10x
Current trading prices of 90€ per share
Even in a pessimistic scenario, the estimated returns it´s still good, 17% per year over five years. *
Target price could be around €140 at three years and €200 at five years.
10. Why are stocks cheap?
current financial crisis
Russia-Ukraine conflict
All technology stocks, especially those of European companies, have suffered the ravages of war
Little known Small Cap company.
Not very liquid, large funds or investors cannot buy large packages of shares, although this is no longer the case...
*This is the magic of small caps, little followed, in discrete markets, they are in an initial phase and large investors can´t invest because those companies are not liquid*
Disclaimer
This analysis is not a buy or sell recommendation, it is my personal opinion and each person should make their own analysis of the company.