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Mastek: Steady as she goes

Jan 14, 2002

Mastek has posted another steady performance for the quarter ending December 2001, 2QFY02 for the company. Though, the numbers for the Indian entity (Mastek Ltd.) indicate a sharp rise in income, the numbers are much sober for the Mastek group. However, consistently, post 3QFY01 the companyís financials continue to be much healthier indicating that Mastek is turning around, though slowly. Mastek Limited
For 2QFY02, the company has a posted a steep 24% sequential growth in topline and 481% jump in net profits. The sharp rise in bottomline is not only due to a significant improvement in operating margins but also due to a sharp decline in interest and depreciation. On a YoY basis, the revenues have increased by 14%. However, the jump in the bottomline is a significant 236%. This is largely due to the improvement in operating margins that have climbed from 25.5% in 2QFY01 to 45.8% in 2QFY02. This has been possible due to the company controlling its costs very effectively. On a YoY basis, costs have fallen by 17%. Mastekís employee costs have shown a marginal decline. It is the traveling and other cost heads where the company has cut corners.

(Rs m) 1QFY02 2QFY02 Change
Sales 193 239 23.8%
Other Income 5 6 11.5%
Expenditure 126 130 2.9%
Operating Profit (EBDIT) 67 109 63.0%
Operating Profit Margin (%) 34.8% 45.8%
Interest 11 1 -94.4%
Depreciation 40 14 -66.6%
Profit before Tax 21 101 376.9%
Tax 5 7 40.0%
Profit after Tax/(Loss) 16 94 480.9%
Net profit margin (%) 8.4% 39.4%
No. of Shares (eoy) (m) 13.9 13.9
Diluted Earnings per share* 4.7 27.1
*(annualised) - -
P/E (X) - 9.7

The contribution of Mastek Ltd. to Mastek groupís revenue has gone up from 31% in 2QFY01 to 36% in 2QFY02. Thus, Mastek Limited represents a very small part of the groupís revenue. The sharp increase in topline could also be due to project being transferred across subsidiaries. This therefore, would not indicate much of a performance. However, this could also be due to a significant account win, in that case being a strong positive.

Mastek Group
The revenues have shown a 2% sequential growth for the group. Considering that during the quarter the Indian companies felt the impact of Sep 11 a growth in topline is quite commendable. The net profits grew even sharply due to the fact that interest cost and depreciation has declined sharply. The company recorded a 48% sequential growth in net profits. On a YoY, basis the revenues declined by 3% and the net profits climbed by 102%.

(Rs m) 1QFY02 2QFY02 Change
Sales 634 647 2.0%
Other Income 5 9 69.2%
Expenditure 520 558 7.3%
Operating Profit (EBDIT) 114 89 -22.3%
Operating Profit Margin (%) 18.0% 13.7%
Interest 12 5 -56.8%
Depreciation 45 15 -66.4%
Profit before Tax 62 77 24.2%
Tax 21 16 -22.9%
Profit after Tax/(Loss) 41 61 48.2%
Net profit margin (%) 6.5% 9.4%
No. of Shares (eoy) (m) 13.9 13.9
Diluted Earnings per share* 11.8 17.5
*(annualised) - -
P/E (X) - 14.9

The operating margins however declined significantly compared to 1QFY02. This is due to a 7.2% sequential rise in costs. Arising mainly from increase in travel & conveyance expenses and other cost heads. The employee costs have risen marginally. On a YoY basis, Mastekís operating margins have improved from 10.5% in 2QFY01. This is due to stock compensation during the corresponding period last fiscal. Excluding this charge operating margins for 2QFY01 would be 13.3% indicating that the companyís operating margins have remained stagnant.

The operating margins could indicate that the company is under intense pricing pressure, for an industry that has aggregate operating margin in the range of 30%, 18% is dismal. Added to this is the fact that the company operating margins have declined. However, this could be due to market environment worsening on back of Sep 11 attacks.

Revenues from the US geography showed a sharp decline (11%, sequential). This fall in revenues was offset by increased business from the Europe and Asia Pacific geographies that grew by 7% and 8% respectively. Revenues from domestic segment grew by strong 44%, though on a smaller base. According to the segment revenue break up provided by the company, its domestic operations have EBIT (earning before interest and taxes) margins of about -53%, while the US and Asia Pacific geographies have very low EBIT margins in the range of around 5%. It is the European operations that are the major grosser for the company with EBIT margins in the range of 35%. Mastek has the distinction of being amongst very few Indian software companies that have Europe as the largest contributor to their revenues.

The service offering that saw the strongest growth was development. Consequently, the contribution from development to revenues jumped from 43% in 1QFY02 to 53% in the current quarter. Though Infosysí numbers have not shown such strong growth, there could be a trend visible indicating renewed interest in new application development. Corporates had almost frozen all new development work in the past in wake of an economic slowdown. This could be a ray of hope for the Indian software industry as development is one of the largest revenue grosser apart from maintenance.

Revenues from maintenance also grew marginally and the contribution remained constant at 31%. The demand for maintenance seems to have stagnated. However, numbers from a few more companies will give a better trend. Contribution of products increased very steeply to reach 2% for 2QFY02. Bucking the general trend in the industry revenues from implementation has shown a sharp decline from 25% in 1QFY02 to 10% in 2QFY02.

Almost all major industry vertical exhibited weakness for 2QFY02. Revenues from government, education and IT & other services showed growth. In an interview with Mr. Ashank Deasi, Chairman, Mastek, had indicated that the company would be focusing on verticals like government and education. However, weakness in major industry verticals like financial services, telecom and manufacturing is a cause for concern. As such steep drop in revenues sequentially could indicate that the company visibility of earnings is likely to be low. Also, the company is working on projects of a relatively smaller size.

Industry verticals as a % of revenues 1QFY02 2QFY02 Change
Financial Services 27.7% 26.3% -3.4%
Telecom 13.5% 8.9% -32.7%
Government 19.9% 21.2% 8.6%
Education 8.0% 13.7% 74.9%
IT & other Services 12.6% 17.7% 43.5%
Retailing 7.8% 4.2% -45.7%
Manufacturing 10.4% 8.0% -21.7%

The demand for fixed price projects has shown a sharp rise. This was evident from Infosysís numbers also. This indicates that the clients are going in for fixed budgets for IT as compared to flexible ones seen in the past. The company now derives 29% of its revenues from fixed price projects as compared to 12% in 1QFY02.

During the quarter the company saw number of active clients decline to 82 from 98. The number of clients added during the quarter was low at 5 compared to 12 in the past quarter. The company has only 15 clients out of the total of 82 who have the potentially of billing of more than US$ 1 m. Thus, the projects it does for the clients could be relatively smaller in size. This increases the risk of the projects being terminated, as mission critical projects are usually larger.

At the current market price of Rs 261, the stock is trading at a P/E multiple of 10x its 2QFY02 (Mastek Ltd.) annualised earnings. While there is significant room for the company to improve margins the concerns are regarding growth. However, the company has entered into a joint venture with Deliotte Consulting. The company earns about two thirds of its revenues of US$ 3 bn from technology competency. This venture could be the major revenues grosser for Mastek group in the near future. Mastek expects topline to grow by 10% to 15% and growth in net profits is expected to be in the range of 150% for FY02. Based on the guidance the companyís P/E on the back of FY02 estimated earnings works out to be 17x. It is unlikely that the company will enjoy such a high P/E considering the fact that its performance is far subdued compared to companies quoting similar P/E. Therefore, the stock price could see a downside in the near future.

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