Execution issues, margin pressure to cap Mindtree's gains from new strategy

Valuations too leave little upside from current levels

Bengaluru-based IT service company Mindtree, which recently outlined its new growth strategy, is targeting industry leading growth with a focus on large deal wins, mining strategic accounts, seamless delivery and strengthening its partner ecosystem. The management announced its intentions to enter the healthcare vertical and strengthen its existing consulting practice. Mindtree also indicated that it is open to considering the M&A route to accelerate growth, a significant change from the past. This is seen as a positive by analysts as they believe this will widen the company’s growth profile. There are, however, concerns surrounding execution and potential margin pressure from the new strategy. 

“Mid-tier companies typically grow by focusing on select verticals, using differentiated services to penetrate an account and cross-sell offerings to scale-up accounts. Mindtree’s broad agenda does not appear to be following the template.” Said Kawaljeet Saluja, Head of Research, Kotak Institutional Equities. “We watch keenly how Mindtree proceeds to execute the broad agenda noting its middling presence in a few verticals and service offerings,” he added. 

With a focus on operational efficiencies, Mindtree’s margins have seen a steady improvement and even hit the highest level since March 2015 in the September quarter. However, normalisation of employee costs and investments to scale up new capabilities may limit the scope for further expansion, say analysts. 

The company is also heavily dependent on its top clients for growth. Top clients have added more than a third of incremental revenues over FY14 to FY20. “Persistent weakness in the Top 2-10 client bucket (-3.5 per cent q-o-q, eight-quarter growth -2 per cent) remains a concern given the 20 per cent contribution to the topline. High exposure to travel, transport, and hospitality is also expected to remain a drag on overall recovery,” said brokerage firm Motilal Oswal in a recent report. 

The sharp runup in the company's share price and premium valuations leave limited room of further upside. At a one year forward price to earning ratio of 23.2 times, the stock trades above its historical mean over the last 12 years, say Morgan Stanley analysts.