Further upsides in Mindtree may be capped, headwinds foreseen

Supply side pressures could hit its efforts to maintain margins above 20 per cent

Mid-cap information technology major Mindtree was the biggest gainer in the IT space over the last month, fetching investors 35 per cent returns. This was over four times the returns of the Nifty IT index over this period. Revenue visibility on the back of record deal pipeline, recovery in travel, transportation and hospitality vertical, strong margin guidance despite cost pressures and a IT midcap rally have acted as tailwinds for the stock.

After the highest organic growth among peers of 7.7 per cent on a sequential basis in Q1, the company is expected to maintain double-digit growth for the full year, outperforming peers. Deal intake for the company remains high with a record value of $504 million in Q1 as compared to the deal wins in the range of $303 million to $393 million over the past five quarters. Growth in net additions (hiring) for the company over the past 12 months at 24 per cent was the highest in the large and mid cap space.

What could help the company is a diversified presence across verticals and contribution from the European market. Analysts at Prabhudas Lilladher Research point out that Mindtree’s investments to expand presence in Europe over the last several quarters are yielding results with record high sequential growth in Continental Europe of 13.1 per cent q-o-q in dollar terms in the June quarter.

While record deals and strong revenue growth are positive, some analysts believe that there could be some headwinds for the stock given high client concentration (top client accounts for 27 per cent of revenues), ability to meet margin targets and supply side pressures. While the company has a target of 20 per cent plus operating profit margin for FY22, an analyst at a domestic brokerage believes it will be tough to achieve that number. This is due to high attrition levels, wage hikes which could hit margins as was the case with L&T Infotech (250 basis points impact) and higher travel costs.

The other factor which may limit upsides are valuations. The stock is trading at 42 times its FY23 earnings estimates as compared to Tier-1 valuations of 21-35 times while its mid cap peers are available at 36-42 times range. Investors should await a sharp correction in the most expensive IT stock in the large and mid cap space before considering investing for the long term.