Mindtree: Digitally sound - Buy

After a stupendous run in prices for much of the last couple of years, the stocks of many quality mid-tier IT players have corrected significantly in the past few months.

Among the prominent ones, Mindtree’s shares too have been knocked down by over 25 per cent in the last three months, mainly because the company’s second quarter numbers were slightly below expectations.

But markets may have overreacted as Mindtree has delivered robust financials and is ahead of most peers in the industry by growing in high double-digits in dollar terms for the past few quarters. The December quarter financials were robust for the company. Given the correction in the stock, investors with a two-year horizon can buy the shares of Mindtree at current levels.

At ₹886, the stock trades at a little over 15 times its likely per share earnings for FY20, lower than the multiples that peers such as L&T Infotech trade at (18 times).

Rapid increase in digital revenues, significant client additions and healthy traction in key verticals such as retail, hi-tech and travel are positives for the company. Operationally, several metrics have picked up reasonably, helping the company better its margins.

In the nine months of FY19, Mindtree’s revenues grew by 29.6 per cent over the same period in the previous fiscal to ₹5,182 crore, while net profits rose by 43.3 per cent to ₹556 crore. The company’s EBITDA margin has been healthy and stable in the 15-16 per cent range.

In dollar terms, the company is likely to end the current financial year with over 15 per cent revenue growth, placing it among the best in the industry on this metric.

Digital push

Over the past couple of years, Mindtree has increased its focus on the digital offerings. The company derives 49.5 per cent of its revenues from its digital service line, up from 43.9 per cent in the previous year. More importantly, digital revenues are growing faster than the overall company’s rate. Even in the recent December quarter, digital revenues grew by a solid 32.5 per cent on a Y-o-Y basis.

This proportion of digital revenues places it among the best in the industry. Of course, in general, many digital projects from clients tend to be on a one-off or pilot basis, which may cause lumpiness in revenues. But that’s been the nature of such deals over the past few years and even top-tier IT players face a similar challenge. Client additions have been healthy for Mindtree. In the last one year, the company has added seven customers in the $5-million category, six in the $10-million band, and one in the $25-million bucket.

The company has also mined its existing client base well in the last one year. Its top five clients account for 33.8 per cent of revenues currently, up from 31.6 per cent a year ago. Its top 10 clients have also increased contribution to revenues at a healthy clip.

Broad-based growth

Mindtree’s largest vertical, hi-tech and media, which accounts for 39.4 per cent of revenues, has grown at a rapid pace over the past four to five quarters, expanding at a rate faster than the overall company’s revenue growth rate. Retail, CPG and manufacturing (22.3 per cent of revenues) and travel and hospitality (16.7 per cent of revenues) too have grown at a reasonably robust pace. The banking, financial services and insurance (BFSI) segment though has been a tad weak. Among service lines, application development and maintenance, testing and infrastructure management and tech support, which collectively account for 87 per cent of overall revenues, have all witnessed significant traction.

Thus, growth has been broad-based across segments and service lines for the company.

Operational improvements

Mindtree has increased the utilisation levels of its workforce significantly over the past one year. The utilisation rate, as of December 2018, is a healthy 76.4 per cent, up from 74.3 per cent in the same period the previous year.

The company has a very attractive offshore-onsite effort mix. About 77-78 per cent of Mindtree’s workforce is deployed in relatively low-cost offshore locations. This proportion is among the best in the industry and optimises costs for the company. This mix also indicates the execution capabilities of the company; despite having a high proportion of digital deals that usually require increased onsite manpower requirement, it has managed to have an optimal mix.

Employee costs, as a proportion of revenues, have declined steadily in the last four quarters.

Attrition has increased mildly in recent quarters, though at 13.4 per cent it is not a cause for any alarm.

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