CMC: Buy

While Europe faces economic and debt crises, the US continues to be a stable and growing market for outsourcing services over the past couple of years. Many mid-tier IT companies have managed to expand their footprint in the North American geography at a healthy pace.

CMC is one such company that has managed to expand both in the US as well as in the Indian market.

A healthy blend of offerings, sustained momentum in winning contracts and increasing tilt towards international (largely the US) revenues are key positives for the company. Synergy with its parent, TCS, is another factor that strongly weighs in its favour.

Investors with a two-year horizon can consider buying the shares of CMC in light of the above growth drivers. At Rs 1,095, the stock trades at 13 times its likely per share earnings for FY14. This is at par with most mid-tier IT companies. But an operating margin in excess of 15 per cent places it among the best in its category.

In FY12, CMC’s revenues grew by 35.5 per cent over 2010-11 to Rs 1,469 crore, while net profits fell 15.4 per cent to Rs 152 crore.

The fall in profits was largely due to near doubling of tax outflows. But this is expected to moderate as the company moves its operations from software technology parks (with fewer tax benefits) to SEZs (that can shelter profits from tax). There was also a sharp increase in employee expenses as a result of higher subcontracting costs (an increase of over 70 per cent to Rs 446 crore). In the days ahead, there would be some relief on this count too.

With tax incidence likely to moderate this fiscal and a reasonable rein-in expected on costs with efforts made to transition projects offshore, the company is expected to be back on track for profit growth and margin expansion.

In the June quarter of the current fiscal, CMC’s revenues grew 48.6 per cent over the same period last year to Rs 452 crore, while net profits expanded by 68 per cent to Rs 58 crore.

Favourable business mix

CMC has evolved from being a hardware-intensive low-margin player to a more services-centric company over the past three-four years, with its service offerings expanding considerably.

It now derives over 89 per cent per cent of its revenues from projects that have significant services component in them, with pure hardware contracts accounting for the rest. The company’s systems integration division with a strong software component (over 57 per cent of revenues), together with application development and maintenance and ‘embedded’ systems, are typically high-margin businesses. This segment continues to grow at or faster than the overall revenue rate of the company.

The more hardware-intensive customer services unit (23 per cent of revenues) too continues to grow, albeit at a slower pace.

The third major division, IT enabled (BPO/KPO) services (15 per cent of revenues), also continues to show traction. This blend of offering gives CMC a better chance at deriving deals that are non-discretionary in nature.

Also, CMC has expanded its client base significantly over the past few years. In the recent quarter too, the company has added 20 customers across geographies, including from India.

The combination of a larger client base and a dispersed geographical footprint offers greater certainty over future revenue flows and improved prospects for growth in such revenues.

International revenues (largely from the US) now account for over 60 per cent of overall revenues, up from 55 per cent last year. International operations that provide better margins and are more complex in nature help CMC climb up the services value-chain.

The association with TCS has helped CMC considerably in terms of both client references and in winning deals.

With regard to its international operations, the company hopes to increase the proportion of projects executed offshore from 25-26 per cent to around 40 per cent over the next couple of years. This would optimise costs.

Strength in Domestic Deals

The government sector, where spend on areas such as rural connectivity, and e-governance is increasing rapidly, is a key market for CMC.

Among others, clients include entities such as Indian Railways, Passport Seva and the Election Commission where heavy volume of data is likely to provide sustainable revenues for the company. These apart, the UIDIA (Aadhar project) and several state transport companies that are looking to implement global positioning systems (GPS) solutions are also CMC’s customers.

India provides around 39 per cent of CMC's revenues. Despite deals having significant hardware component, solutions such as GPS and UIDAI would provide steady annuity revenues for the company over the long-term.

A recent report from research firm IDC states that the total IT market in India is expected to grow to $43.57 billion in 2012, up from $37.46 billion in 2011, an expansion of 16.3 per cent.

Also, verticals such as BFSI, Communication & Media, Government, Manufacturing and IT/ITeS are expected to grow at 14-18 per cent annually over 2011-15.

Risks

Competition in the system integration space from players such as Wipro Infotech and HCL Infosystems would mean pricing pressure.

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