Positive outlook, reasonable valuations

MindTree continued its strong run in the quarter ended June, announcing higher-than-expected net profit and earnings before interest, tax, depreciation and amortisation (Ebitda) margin. Strong growth in information technology (IT) services, cost efficiencies and the depreciation in the rupee boosted profitability in the quarter.

This is the fourth quarter in which the company’s results were better than expected, resulting in another round of earnings upgrades by brokerages. Emkay Global’s IT analyst said, “MindTree has done well this quarter. We have raised full-year earnings estimates 6-6.5 per cent after the results. We believe the full-year guidance should be achievable. We have a ‘buy’ rating on the stock, with a target price of Rs 730.” Analysts at Religare, too, raised their earnings estimates for this financial year 17 per cent to Rs 787 a share.

The revised guidance also appears strong. For 2012-13, analysts expect MindTree to record 10-12 per cent revenue growth, while its earnings growth is pegged at 27-28 per cent. The management expects margins to be impacted by 200 basis points in the September quarter, and factors like the employee utilisation rate and cost efficiencies should help offset the pressure and enable MindTree maintain current margins. For 2012-13, analysts expect margins to rise about 200 basis points. The company’s stock, which rose four per cent after the results were announced, ended the day down 2.2 per cent, compared to the Bombay Stock Exchange Sensex’s fall of one per cent.

At 8.5 times 2012-13 estimated earnings, however, the valuations appear undemanding. “MindTree results were in line with our expectations. Annualised first-quarter earnings per share (excluding forex gains) would be Rs 78-80, and if the current margin trend continues, we believe there could be 10-20 per cent upside risk to consensus estimates. MindTree trades at single digit price/earnings multiples and remains our preferred mid-cap stock. We believe in-line revenues and strong earnings performance in the first quarter should support current multiples,” Vipin Khare and Gaurav Rateria of Morgan Stanley Research wrote in a post-results note on MindTree.

Margin surprises
At 0.2 per cent, volume growth remained flat. However, stable pricing and rupee depreciation aided its growth in revenue during the quarter. Unlike its larger peers, MindTree’s management indicated the company was not facing any pricing pressure in IT services as well as in products divisions. It expects pricing to hold on to current levels. On the demand side, it expects to grow at 11-14 per cent this financial year, the rate projected by the National Association of Software and Services Companies. This implies sequential growth of three-four per cent for the next three quarters, which looks achievable, given its performance in the first quarter.

The company’s Ebitda margins rose over 200 basis points, compared to the quarter ended March, led primarily by a weaker rupee and cost efficiencies. Though the company carried out part-wage rises (which impacted Ebitda margins by about 100 basis points), this was more than offset by forex gains of 230 basis points and cost efficiencies of 80 basis points, resulting in margin expansion.

On the flipside, contraction in the product engineering services (PES) division and lower employee utilisation rates were key negatives. The PES division continues to struggle, recording five per cent contraction on a sequential basis. However, it bagged two orders (above $10 milllion) recently, and MindTree’s management expects this segment to record sequential growth in the quarter ending September. Analysts, however, continue to watch this space closely.