21 Sep 2015 20:15 IST

Digital roots to drive growth

Niche focus and expanding digital business have helped the company expand

Investors with a medium to long-term horizon can consider buying the stock of Mindtree. It is down about 15 per cent since April due to the broader market correction.

At ₹1,399, the stock trades at about 17 times its estimated earnings of 2016-17. This is marginally expensive compared with peers such as Cyient, Persistent Systems and Hexaware (trading at about 15-16 times), but seems justified, given Mindtree’s strong June quarter results and good revenue growth visibility from new orders.

In the recent June quarter, Mindtree reported a 4.8 per cent sequential sales growth to $141.3 million, much better than the 0.1 per cent growth in the March quarter. In rupee terms, revenue in the June quarter grew 6.9 per cent to ₹982 crore.

Increase in contribution from digital revenue, healthy growth in BFSI and retail verticals helped. The BFSI segment that contributes to a fourth of revenue recorded a 10.5 per cent growth sequentially.

Among service lines, application maintenance reported 9 per cent growth and IMTS (infrastructure management and tech support) grew 6 per cent.

Peers Cyient, Persistent Systems and KPIT Technologies reported drop in revenues in the June quarter.

The company’s niche focus (BFSI, retail, manufacturing and hospitality largely), proven execution skills and an aggressive ramp-up of the digital business are arguments in favour of the stock.

In the June quarter, the company reported attrition at a reasonable 18.4 per cent, a tad higher than the 18.2 per cent in the previous quarter. But the utilisation rate improved marginally to 71.9 per cent from 71.1 per cent.

Improved revenue visibility

In 2014-15, Mindtree’s revenue grew 16.4 per cent. For 2015-16, the company is confident of beating Nasscom’s estimate of 12-14 per cent growth for the industry. This looks achievable, given the renewed traction in orders for the company. In the June 2015 quarter, Mindtree reported total order wins of $208 million — the strongest in the last several quarters and up from the March quarter’s $164 million.

Of the new orders, projects worth $159 million are scheduled for execution in the current year. The company added one new client to the $50-million-plus category in the June quarter.

Now, with the US economy too showing green shoots, outlook is positive. Mindtree derives over 60 per cent of its revenue from North America. In the June quarter, the company saw its US business record 9 per cent sequential growth (in dollar terms), more than making up for the 3.1 per cent decline in revenue from Europe.

The ADMS (IT application, development and maintenance services) business has also picked up pace and was a major revenue driver in the June quarter. Mindtree has been aggressively expanding its digital presence through acquisitions.

In the June quarter, it acquired Bluefin Solutions and Relational Solutions, both established businesses in the digital space. Bluefin Solutions is a UK company that specialises in SAP HANA and provides analytics on transaction data on real time basis. Relational Solutions is a US-based company that provides analytic solution to CPG (consumer packaged goods) companies. It has about 30 big CPG clients, including two of the global top 10 FMCG companies. Both the acquisitions will add to Mindtree’s earnings and help cross-sell products in the US and the UK markets.

In the June quarter, digital business’ contribution to Mindtree’s revenue increased to 35 per cent, from 32 per cent in the March quarter. The digital business, which includes technologies for social, mobility, analytics and cloud (SMAC), grew 12 per cent sequentially, much faster than the overall 4.8 per cent growth.

Margins may remain weak

Globally, though IT spends are slowing, demand for digital solutions in retail, BFSI and hospitality sectors — Mindtree’s focus areas — are growing. The company’s aggressive moves to grow inorganically and build up its digital capabilities should benefit it in the coming years. But, in the near term, the investments that go into building the platform and the need to keep more employees onsite may add to pressure on margins.

Eventually, as the digital business attains large scale with a higher offshore component, margins should improve. In the June quarter, Mindtree’s operating margin of 17.6 per cent was down 190 basis points from the March quarter.

This was mainly due to higher visa cost as the company had applied for more visas due to a good pipeline of orders.

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