Cloud Data And AI Demand Will Drive Powerful Long Term Business Transformation

Catalysts

About Capgemini

Capgemini is a global consulting and IT services leader helping organizations modernize their technology, transform operations and harness data and AI at scale.

What are the underlying business or industry changes driving this perspective?

• Rapidly growing client demand for cloud, data and AI driven transformation, evidenced by strong traction in Cloud and Data and AI offerings and 7 percent of Q2 bookings already linked to Gen AI and Agentic AI, should translate into structurally higher, mix driven revenue growth and resilient gross margins.
• Accelerating shift toward intelligent operations and Agentic AI powered business process transformation, reinforced by the contemplated WNS acquisition and high single digit growth in Business Services, positions Capgemini to capture larger, recurring outsourcing deals that can expand operating margin and earnings over time.
• Rising investment in defense, sovereignty and high security digital infrastructure in Europe, where Capgemini is one of the few scaled local players with end to end capabilities, supports multi year contract visibility that can lift bookings, backlog and cash flow conversion.
• Strengthening demand in higher growth regions and sectors, including Asia Pacific and Latin America at plus 8.7 percent and double digit Financial Services and TMT in those markets, creates a favorable geographic and sector mix shift that should support faster group revenue growth and improved net profit.
• Ongoing portfolio shift toward higher value Strategy and Transformation and Applications and Technology services, combined with disciplined cost management and increasing offshore leverage at 59 percent, is likely to drive gradual operating margin expansion and normalized EPS growth beyond the current soft macro environment.

Assumptions

This narrative explores a more optimistic perspective on Capgemini compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts. How have these above catalysts been quantified?

• The bullish analysts are assuming Capgemini's revenue will grow by 6.4% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 7.1% today to 9.2% in 3 years time.
• The bullish analysts expect earnings to reach €2.5 billion (and earnings per share of €14.19) by about December 2028, up from €1.6 billion today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as €1.9 billion.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 19.7x on those 2028 earnings, up from 15.4x today. This future PE is greater than the current PE for the GB IT industry at 15.9x.
• The bullish analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.27%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The group is only barely back to growth at plus 0.2 percent in H1 and guiding to between minus 1 percent and plus 1 percent constant currency for the full year. If the macro environment remains soft or deteriorates, particularly in Continental Europe and France where revenues are already declining, Capgemini could remain in a low growth regime for several years, capping revenue expansion and limiting operating leverage on earnings and net profit.
• Manufacturing, automotive and parts of aerospace are structurally weak and still dragging on performance, while consumer goods and retail and services are also under pressure. If these sectors face prolonged restructuring and lower tech spend as business models shift, the company risks a sustained drag from legacy verticals that offsets strength in financial services and TMT, weighing on group revenue growth and gross margin.
• Pricing pressure in a very competitive market, including client expectations that Gen AI and Agentic AI savings are passed back through lower rates and upfront concessions on vendor consolidation deals, could structurally compress project profitability and delay margin recovery. This could lead to stagnant or declining gross margins and constrain operating margin expansion and earnings growth over time.
• The strategic shift to higher offshore leverage at 59 percent, ongoing headcount reductions in Europe and elevated restructuring costs that are expected to remain similar to 2023 highlight a multi year workforce realignment that may not fully match demand patterns. If utilization or pricing disappoints or attrition rises further, this could erode productivity benefits, driving higher restructuring and severance charges and depressing operating profit and basic EPS.
• Despite solid bookings and a new EUR 2 billion multiyear buyback funded largely by organic free cash flow, near term free cash flow generation is under pressure from weaker margins, FX headwinds and higher cash tax and DSO pressure. If cash conversion does not recover in the second half as planned, Capgemini may need to moderate shareholder returns or M&A, undermining the investment case that assumes robust free cash flow growth and balance sheet strength supporting higher long term earnings per share.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bullish price target for Capgemini is €218.37, which represents up to two standard deviations above the consensus price target of €171.93. This valuation is based on what can be assumed as the expectations of Capgemini's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of €225.0, and the most bearish reporting a price target of just €130.0.
  
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2028, revenues will be €26.6 billion, earnings will come to €2.5 billion, and it would be trading on a PE ratio of 19.7x, assuming you use a discount rate of 9.3%.
  
• Given the current share price of €141.65, the analyst price target of €218.37 is 35.1% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.