Margin pressures, valuations could restrict Mindtree's upside

The Street, however, is bullish on revenue growth prospects this year for Mindtree as well as for the midcap IT space

Strong revenue growth and margin outlook post its stellar June quarter results saw Mindtree stock gain about 8 per cent in trade on Wednesday. The management guided for a double digit sales growth and margins at 20 per cent for FY22. Strong growth expectations rubbed off on the broader mid cap IT sector with L&T Infotech, Mphasis, L&T Technology and Coforge gaining between 4-6 per cent.

The basis for the company’s positive growth commentary was the record order book at $540 million as compared to the average quarterly run rate of $375 million. In addition to a healthy deal pipeline, recovery in travel, transport and hospitality vertical and continued traction in digital-related contracts are key positives from the growth perspective. Most brokerages expect a 20 per cent plus growth in FY22.

Say analysts led by Mukul Garg of Motilal Oswal Financial Services, “Combined with strong deal wins in the last two quarters (average book-to-bill ratio of 1.5 times), Mindtree is expected to deliver dollar revenue growth of 23 per cent YoY in FY22, one of the highest in our coverage universe.”

What reinforces the company’s outlook is the strong employee additions in the quarter. The company’s headcount grew by 14.5 per cent on a sequential basis after it added 3,442 employees, its highest ever addition in a quarter. Say Kawaljeet Saluja and Sathishkumar S of Kotak Institutional Equities, “We believe the strong additions will be used for three reasons—reduce subcontractor dependence, build a bench that is running pretty thin (utilization of 83 per cent is unsustainable) and meet future demand.”

The 160-basis-point reduction in operating profit margins (OPM) on a sequential basis to 20.3 per cent was largely due to a surge in subcontracting and hiring costs which were up 170 basis points.

While the management has guided for an OPM of 20 per cent in FY22, analysts believe this will be difficult to achieve given that discretionary costs including travel will make a comeback. An analyst at a domestic brokerage believes that maintaining margins across the mid-cap IT companies will be a tough challenge unlike larger IT peers who have more levers and scale to manage these pressures.

Given unsustainable margins and the sharp price run up of the stock (30 per cent over three months), brokerages believe near-term upsides are priced in. Investors should await deal flow momentum and the company’s ability to stick to stated margin guidance in the coming quarters before considering the stock.