Mindtree's premium valuations sustainable

Expectations of industry-leading growth and relatively stable client budgets are key reasons

The Mindtree scrip made a new 52-week high of Rs 1,322 a share on January 1, 2015. Continued strength in the company's financial performance, expectations of steady margins and all-round growth across verticals and service lines are key reasons for the stock's strong run (67 per cent return) in the past year. This trend in operational performance is expected to continue in FY16 as well, believe analysts.

Mindtree has positioned itself strongly in select verticals namely banking, financial services and institutions; retail; travel and transportation. Over FY10-14, Mindtree's information technology services business (72 per cent of overall revenues) has grown ahead of the industry at a compounded annual growth rate (CAGR) of 25 per cent, led by strong traction in its infrastructure management services offerings.

However, this growth is partly offset by a muted show in the hi-tech segment, which forms 28 per cent of its revenues. Even though this segment reported muted growth in FY12 (up 0.2 per cent) and FY13 (down 4 per cent), there was some improvement in FY14 with a growth of 5.3 per cent, fuelling the stock price. This trend is likely to continue in future as well and expectation of this all-round growth is a key reason behind the Street's enthusiasm for Mindtree.

The company has made aggressive investments in selling and marketing activities in the digital business, which have started fructifying in the form of new client adds. Nearly half its new client additions in the past year are in the digital space. This vertical will be a key growth engine in the days to come. Going forward, analysts expect the company's dollar revenues to grow at 16-17 per cent CAGR over FY14-17 and earnings to grow at 20-22 per cent. Mindtree's earnings before interest, taxes, depreciation, and amortisation margin stood at 19.8 per cent in the September 2014 quarter and is likely to be stable at these levels going forward as well. Analysts believe the benefits of higher investments in selling and marketing activities along with the scope to scale up utilisation from the current low levels of 73.5 per cent will offset the impact of wage hikes and currency.

At Friday's closing price, Mindtree shares trade at 17 times FY16 estimated earnings, much ahead of its historical average one-year average price/earnings of 11 times. This premium is expected to sustain given the potential to scale up digital business, management confidence of industry-leading growth and stable margins.

While the December 2014 quarter will be a seasonally weak quarter due to higher number of holidays and cross currency headwinds from a stronger dollar, the trend will be across the IT sector as a whole and annual growth trends are intact for Mindtree.