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MindTree: Other income dampens net - Views on News from Equitymaster

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MindTree: Other income dampens net
Jan 25, 2008

Performance summary
  • Topline expands by 2.5% QoQ during 3QFY08, largely due to 2.6% QoQ increase in volumes and 5% QoQ improvement in onsite and 1% QoQ improvement in offshore billing rates.
  • Operating margins expands by 1% QoQ - largely due to decline in S,G&A expenses.

  • PAT declines by 23% QoQ during the third quarter - impacted by implementation of hedge accounting in other income.

  • Adds 23 new clients and 523 employees in 3QFY08. Annualised attrition up 0.3% to 16%.

Financial performance: A snapshot...
(Rs m) 2QFY08 3QFY08 Change 9MFY07 9mFY08 Change
Sales 1,820 1,865 2.5% 4,338 5,300 22.2%
Expenditure 1,524 1,545 1.3% 3,534 4,428 25.3%
Operating profit (EBDIT) 295 320 8.5% 804 871 8.3%
Operating profit margin (%) 16.2% 17.2%   18.5% 16.4%  
Other income 103 35 -66.1% 45 200 344.3%
Depreciation 81 89 10.3% 178 249 40.1%
Interest 18 16 -11.7% 23 43 84.3%
Profit before tax 299 250 -16.3% 648 779 20.2%
Tax 28 42 51.3% (7) 94  
Profit after tax/(loss) 271 208 -23.3% 655 685 4.6%
Net profit margin (%) 14.9% 11.2%   15.1% 12.9%  
No. of shares (m)         37.9  
Diluted earnings per share (Rs)*         24.6  
P/E ratio (x)*         13.9  
* On a trailing 12-month basis

What has driven performance in 3QFY08?
  • MindTree recorded a 2.5% QoQ topline growth during 3QFY08, aided by 2.6% QoQ growth in volumes and 5% QoQ improvement in onsite pricing and 1% QoQ improvement in offshore pricing. The IT services segment recorded a 2.5% QoQ growth in revenues while the R&D segment recorded 2.7% QoQ growth in revenues. The revenues from R&D segment are generally volatile as the revenues are mostly project based but over the past two quarters, the company has shown decent growth in this segment. MindTree consulting acquired Purple Vision in November for US$ 6.55 m but the 3QFY08 results does not include revenues from this acquisition. The company also increased its topline guidance to US$ 186 m from an earlier one of US$ 180 m. On a nine-month comparison, the revenues have increased by 22% YoY. The company added 23 new clients and 523 employees in 3QFY08. However, annualised attrition went up by 0.3% to 16%.

    R &D Service offerings 2QFY08 % of total 3QFY08 % of total Change
    Storage and servers 160 39.2% 163 38.9% 1.9%
    Consumer appliances 112 27.4% 123 29.4% 10.2%
    Communication systems 45 11.0% 54 12.9% 20.4%
    Automotive and industrial systems 78 19.1% 62 14.8% -20.4%
    Others 13 3.3% 17 4.0% 24.4%
    Total 409 100.0% 420 100.0% 2.7%
               
    IT Service offerings 2QFY08 % of total 3QFY08 % of total Change
    ADM 1,213 86.0% 1,184 81.9% -2.4%
    Consulting 68 4.8% 51 3.5% -25.3%
    Package implementation 24 1.7% 75 5.2% 213.4%
    Testing 49 3.5% 91 6.3% 84.4%
    IMS 55 3.9% 43 3.0% -21.2%
    IP licensing 1 0.1% 1 0.1% 2.5%
    Total 1,411 100.0% 1,445 100.0% 2.5%

  • MindTree’s operating margins expanded by 1% QoQ during 3QFY08 aided by a mere 2% QoQ increase in staff costs and a 3% QoQ decline in S,G&A expenses. On a nine month comparison, the salary costs have increased by 31% YoY. The increase in salary costs is mainly on account of increase in headcount and the revision in increment policy from 2007-08. Increments from the current year onwards will be staggered over the period so that the margins can be maintained in a narrow range.

    Segmental Performance
    (Rs m) 2QFY08 3QFY08 Change
    IT Services-Revenues 1,411 1,445 2.5%
    % of total revenues 77.5% 77.5%  
    PBIT margins 17.1% 17.4%  
    R&D Services-Revenues 409 420 2.7%
    % of total revenues 22.5% 22.5%  
    PBIT margins 14.3% 16.4%  
      1,820 1,865 2.5%

  • MindTree’s bottomline fell by 23% QoQ in the third quarter mainly due to implementation of hedge accounting. This impacted the profits by US$ 2 m. However, on a nine-month comparison, the other income has increased by 344% YoY primarily because of interest income on deposits and forex gains on forward cover. Higher tax outgo didn’t help the matters either.

What to expect?
At the current price of Rs 344, the stock is trading at a multiple of 7.3 times our FY10 estimated earnings. The company has increased its revenues guidance from US$ 180m to US$ 186 m but has maintained the profit guidance at US$ 22.6 m. This is mainly because of the appreciating rupee, which is the key concern for the company. Another concern is high proportion of development work in the company’s service offerings. The company is continuously reducing the proportion of development work on a QoQ basis, as these are project-based service, which are likely to get hit in the event of downturn in US, which now looks inevitable. But this proportion of development services is still over 52% of revenues, which we believe is also a significant risk for the company. However, the stock has fallen below the IPO price and is trading at very attractive valuations. We remain positive on the company but strictly from a two to three year holding period, as the stock may not perform in the near term.

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