Mindtree: Q3 and guidance strong, but high attrition remains a concern

Valuation at 38x estimated FY23 earnings for last year's top IT stock performer leaves little room for disappointment

Mindtree declared strong results and guidance for the third quarter of financial year 2021-22 (Q3FY22). However, attrition rates grew, which is a concern. Revenue grew 4.7 per cent sequentially (33 per cent year-on-year, or YoY) to $366.4 million, although Q3 is usually soft.

The Ebitda (earnings before interest, taxes, depreciation, and amortisation) margin rose by 1 per cent to 21.5 per cent. In constant currency rupees, Mindtree saw 5.2 per cent growth in revenues on QoQ (quarter-on-quarter) basis. The reported PAT (profit after tax) of Rs437. 5 crore was up 10 per cent QoQ and 34 per cent YoY.

Revenue growth in business lines (dollar and QoQ), was led by data and intelligence and cloud services, which grew 7.7 per cent and 7.1 per cent, respectively. Customer success grew 3.9 per cent and enterprise IT grew 2.2 per cent.

Among regions, North America grew 5.1 per cent, Continental Europe was up 6.9 per cent, the UK and Ireland declined 7.1 per cent, and Asia Pacific and West Asia grew 14.7 per cent.

In its guidance, the company said it was confident about double-digit revenue growth, driven by strong deal wins, a steady deal pipeline and broad-based revenue growth. Mindtree should deliver better than 20 per cent operating margins in FY22. Deal wins were at $358 million (about the same sequentially) taking the value of deals in the first three quarters to about $1.2 billion, a 21 per cent rise YoY. The cloud space provided 10 new deals, due to an enhanced relationship with a leading hyperscaler.

The improved margins can be attributed partly to cross-currency gains, but the company remains confident of margins above 20 per cent, given revenue growth, demand created by WFH paradigms and a flatter employee structure. It is looking to induct 1,500 fresh graduates per quarter. Margin pressures could arise from rising costs of employee compensations in a tight job market. The induction of freshers should reduce dependencies on sub-contractors, which will reduce expenses further. Net headcount increased 2,277 in Q3. Utilisation declined to 81.5 per cent from 82.9 per cent last quarter. Attrition grew to 22 per cent in Q3, versus 18 per cent in Q2.

The growth was broad-based across verticals, geographies, and service lines. Mindtree’s growth momentum is expected to continue. In particular, it’s worth mentioning a bounce in the travel vertical, which is almost back to pre-pandemic levels. Travel was up 7.3 per cent QoQ, while communications, media and tech grew 6 per cent and BFSI was up 4.3 per cent with retail, CPG (consumer packaged goods) and manufacturing flat sequentially. The smallest vertical, healthcare (1.3 per cent of revenue), grew 29.2 per cent QoQ.

Valuations are fairly high at 38x PE for expected FY23 earnings. Most analysts seem bullish on the stock, but it fell from Rs4,744 to Rs4,547 after the results were declared, which could indicate that the Street was disappointed, probably by the attrition rate. Looking at three leading brokerages, one-year price targets range between the current price of Rs4,550 to Rs5,900, which is the most bullish. Mindtree has been the best performer in the Nifty IT Index over the last year, returning 160 per cent while the index rose 44 per cent.