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Mastek: YoY effect

Jan 14, 2003

While Mastek's numbers for 2QFY03 are rather unappealing, they have been received well by the markets due to the YoY effect. On a sequential basis, the company's revenues have grown by 5% while the bottomline is up 7%. The sequential growth in net profits for 2QFY03 has been aided by steep rise in other income. However, on a YoY comparison the company's net profits have jumped 165%. The topline has grown by 47%. This sharp increase in bottomline comes on the back of a significant expansion in operating margins. The figure has increased from 13.6% in 2QFY02 to 20.5% in 2QFY03. This improvement is due to the revenues growing at a much faster rate as compared to employee costs. As compared to the YoY revenue growth for 2QFY03 (47%), the employee costs have grown by 18%. Consequently, employee costs as a percentage of revenues have fallen sharply from 63% to 51%. However, on a sequential basis the operating margins have shown only a marginal improvement.

(Rs m) 1QFY03 2QFY03 Change 1HFY02 1HFY03 Change
Sales 911 958 5.2% 1,286 1,869 45.3%
Other Income 5 16 200.4% 14 22 56.9%
Expenditure 726 761 4.9% 1,106 1,488 34.5%
Operating Profit (EBDIT) 185 196 6.4% 180 381 111.7%
Operating Profit Margin (%) 20.3% 20.5%   14.0% 20.4%  
Interest 2 1 -15.7% 7 3 -55.1%
Depreciation 20 32 62.3% 48 52 10.1%
Profit before Tax 168 179 6.3% 140 347 148.9%
Extra-ordinary income / (expense) - -   - -  
Tax 16 16 3.0% 37 32 -12.9%
Profit after Tax/(Loss) 152 163 6.7% 102 315 207.5%
Net profit margin (%) 16.7% 17.0%   8.0% 16.9%
No. of Shares (eoy) (m) 14.0 14.0   14.0 14.0  
Diluted Earnings per share* 43.7 46.6   14.7 45.2  
*(annualised)            
P/E (X)   12.4     12.8  

Geography
The QoQ growth in 2QFY03 topline mainly stemmed from the American geography. This is one region where the company has not performed well in the past. Its efforts to streamline operations seem to be showing positive results. The growth in revenues from the joint venture with Deloitte Consulting also continued to be strong. However, revenues from the company's most dominant geography, Europe, showed a marginal decline. A numbers comparison for 1HFY03 indicates that the company has managed growth well from all the geographies. The company has indicated that its engagements with clients in the US are shaping out well. During the quarter, Mastek bagged projects from two US insurance companies based on its performance during previous engagements. Thus, going forward the companies should continue to post a strong growth from the US geography.

(Rs m) 1QFY03 % Of revenues 2QFY03 % Of revenues Change 1HFY02 % Of revenues 1HFY03 % Of revenues Change
North America 238 26.2% 295 30.8% 23.9% 381 29.6% 534 28.6% 40.2%
Europe 550 60.4% 540 56.3% -1.9% 791 61.5% 1,090 58.3% 37.8%
Asia Pacific 55 6.1% 63 6.6% 13.9% 92 7.2% 118 6.3% 27.9%
Joint Venture with Deliotte 35 3.9% 44 4.6% 24.8% 5 0.4% 80 4.3% 1561.3%
India 32 3.5% 16 1.7% -49.6% 17 1.3% 48 2.5% 179.4%
Total 911 100.0% 958 100.0% 5.2% 1,286 100.0% 1,869 100.0% 45.3%

Service offerings
During the quarter the growth in topline was primarily due to increase in revenues from development and maintenance. However, revenues from products and implementation declined sharply. The drop in revenues from implementation could be due to the fact that the joint venture with Deliotte Consulting is into a similar line of business. The joint venture is now looking at the possibility of offering services in the applications outsourcing space. With corporates increasingly looking towards IT outsourcing to trim operational costs, Indian IT services firms plan to tap this huge business opportunity. As a first step, IT majors like Infosys are looking to tap the applications outsourcing segment of the IT outsourcing market.

Mastek's revenue growth for 1HFY03 has been from largely from a single revenue stream, development. Revenues from development have grown by 92% compared to 1HFY02. This concentration is a cause for concern. The other revenue stream that has shown a strong growth in revenues during the half year is the joint venture with Deloitte. This engagement has the potential of swift growth going forward and could add pace to the topline growth. The software sector has seen a strong growth in revenues from services like maintenance during this period. For Mastek however, there has been almost no growth from this segment.

(Rs m) 1QFY03 % Of revenues 2QFY03 % Of revenues Change 1HFY02 % Of revenues 1HFY03 % Of revenues Change
Development 608 66.8% 645 67.3% 5.9% 650 50.6% 1,253 67.1% 92.7%
Maintenance 189 20.7% 213 22.2% 13.0% 401 31.1% 402 21.5% 0.3%
Products 10 1.0% 5 0.5% -49.6% 11 0.8% 14 0.8% 31.1%
Implementation 69 7.5% 51 5.3% -25.6% 219 17.1% 120 6.4% -45.4%
Joint Venture with Deliotte 35 3.9% 44 4.6% 24.8% 5 0.4% 80 4.3% 1561.3%
Total 911 100.0% 958 100.0% 5.2% 1,286 100.0% 1,869 100.0% 45.3%

Industry verticals
The company saw a strong growth in revenues from the banking, financial services and insurance (BFSI) vertical, in line with the sector trend. It signed up with a client in Europe to develop a solution for derivatives trading. Also, it won an order from one of the largest asset management companies in the US for migrating applications from legacy systems. For 1HFY03, the contribution to revenues from the BFSI segment has jumped from 27% in 1HFY02 of the total revenues to 41%. The company has also seen a sharp rise in the contribution to revenues from projects awarded by the Government Utilities in Europe. This includes the London Congestion Charging Scheme (LCC) project.

While Mastek saw an 18% sequential growth in revenues from the telecom vertical, for 1HFY03 the revenues showed a decline of 34%. The revenues from the retailing and manufacturing verticals were also sharply lower for the half-year. The revenue mix for the company based on industry verticals is a cause for concern. The company earns more than 82% (1HFY03) of its revenues from the BFSI industry and Government projects. While the BFSI space is fiercely competitive, Government projects are among the first to be prone to protectionist moves in order to protect jobs in the concerned economy. Recently New Jersey passed a law that prohibits Government offices from outsourcing work outside US.

(Rs m) 1QFY03 % Of revenues 2QFY03 % Of revenues Change 1HFY02 % Of revenues 1HFY03 % Of revenues Change
Financial Services 227 25.0% 299 31.2% 31.6% 346 26.9% 526 28.2% 52.2%
Telecom 43 4.8% 51 5.3% 18.0% 144 11.2% 95 5.1% -34.2%
Government 278 30.5% 271 28.3% -2.6% 264 20.5% 549 29.4% 108.0%
Education 78 8.6% 45 4.7% -42.0% 139 10.8% 123 6.6% -11.3%
IT & other Services 178 19.6% 191 19.9% 6.9% 194 15.1% 369 19.7% 89.6%
Retailing 23 2.5% 21 2.2% -6.6% 77 6.0% 44 2.4% -42.0%
Manufacturing 47 5.2% 35 3.6% -25.8% 117 9.1% 82 4.4% -30.0%
Joint Venture with Deliotte 35 3.9% 44 4.6% 24.8% 5 0.4% 80 4.3% 1561.3%
Total 911 100.0% 958 100.0% 5.2% 1,286 100.0% 1869 100.0% 45.3%

At the current market price of Rs 580, the stock is trading at a P/E multiple of 13x its 1HFY03 annualised earnings. The company's valuations are on the lower side and future growth in earnings can justify these valuations. Also, the improvement in business prospects for the sector could help the company post strong growth rates in the foreseeable future. However, the concern is regarding significant concentration in terms of service offerings. Development and maintenance are responsible for 89% of the company's revenues. Thus, the element of risk while investing in the stock despite valuations being on the lower side is significantly high.


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