MindTree on a recovery path

Improving financial performance and attractive valuations make it a candidate for re-rating.

MindTree’s entry and subsequent exit from the mobile handset manufacturing business (via the Kyocera buyout), coupled with the exit of co-founder Ashok Soota, has significantly pulled down the stock. The stock has underperformed the Sensex, falling 28 per cent in 2011 against the benchmark’s 23 per cent. It trades at 9.75 times the 2011-12 estimated earnings and 8.9 times that of 2012-13.

However, analysts are turning bullish on the company, given its renewed focus on information technology services and successful turnaround strategies. After strong September quarter results, most analysts have raised MindTree’s earnings per share estimates by seven to nine per cent for FY12 and FY13. Vipin Khare of Morgan Stanley, in a November report, expects net profit to grow 50 per cent over the year in 2011-12. He forecasts strong annual revenue and earnings growth of 17 per cent and 18 per cent, respectively, over 2011-14.
 

IMPROVING PROSPECTS
Rs crore	FY11	FY12E	FY13E
Revenues	1,509	1,912	2,266
% chg	16	27	19
Ebitda margin (%)	11.8	13.6	14.3
chg (bps)	-730	183	70
Net profit	101	171	193
% chg	-53	69	13
EPS (Rs)	24.7	41.7	47.2
% change calculated year-on-year, E:Estimates Source: HSBC Global Research

MindTree has multiple levers to aid margin expansion. Increasing its offshore revenues, rationalising the employee structure and pushing up utilisation rates are some. Analysts expect MindTree to clock an earnings growth of 23-25 per cent over 2010-13. On the flipside, a worsening global macroeconomic scenario will remain a key factor to monitor and could hit growth and margins.

Back to basics
After an unsuccessful foray in the wireless business through its Kyocera buyout, the company exited the loss-making business and has renewed focus on the core IT services business. MindTree's three-pronged strategy of higher mining of existing clients, focusing on existing businesses and improving operational efficiencies seems to be working. A compounded revenue quarterly growth rate of around 5.6 per cent over the past six quarters is an indicator. The company's Ebitda (earnings before interest, taxes, depreciation and amortisation) margin expansion (despite wage rises) of 170 basis points to 12.9 per cent in the first half of this financial year over the March quarter is another.

The realignment of its businesses into two units (as against seven previously), namely product engineering services (PES) and IT (64 per cent of revenue) is driving operational efficiencies. It has been rationalising small accounts to concentrate on core businesses (total active clients down by 13 in the September quarter sequentially). Also, its contribution from the top five as well as he top 10 clients has been rising in the past two quarters, aiding top line growth.

After several quarters of sluggishness, the PES business grew 8.5 per cent in the September quarter. However, this may just be a one-off, as the company is feeling the pinch of delayed discretionary spends from its clients. N Krishnakumar, CEO and managing director, says: “Clearly, in our product engineering services, we will not be able to sustain the same high level of growth because this quarter we had a large deal which contributed to almost three per cent of that growth. Further, two of the segments in PES, consumer devices and the semiconductors business are starting to see some level of uncertainty. So, that growth would be muted. But, clearly on our IT services we continue to see good growth,momentum, factoring in for the seasonality in Q3, which has a lower number of working days and holidays.” The management believes the PES business can grow by 18-20 per cent in the long term. Going forward, the company expects to ramp up the revenue pie of IP-led (Bluetooth and digital surveillance) businesses from the existing two-three per cent to six-seven per cent.

MindTree is expected to clock gains of 300-350 basis points in Ebit margins for 2011-12, believe analysts. While Krishnakumar believes pricing would be stable, he also expects improved efficiencies to boost margins. Also, a weaker rupee will aid margin expansion, given MindTree's higher exchange sensitivity than its peers.

Q3: Strong outlook
The management expects revenue growth to be 2.5-3 per cent in a seasonally weak December quarter. While this is lower than in the first half of 2011-12, it is still expected to be higher than its peers. The company remains optimistic on demand and has not got any negative message from its top clients, says the management.