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CMC: Steep valuations

Feb 19, 2003

For CMC, the December quarter was a healthy one. The company, which is now part of the Tata group, has been able to post a 21% growth in its revenues YoY during the quarter. However, the highlight of the performance was a steep improvement in operating margins as the company reigned in its expenses tightly. Consequently, it’s net profits jumped by 45% during the same period. A decline of 11% in other expenses helped the company post better margins for 3QFY03. However, the company’s performance has been much better than it appears. An 81% decline in other income has subdued the company’s bottom line growth.

(Rs m) 3QFY02 3QFY03 Change 9mFY02 9mFY03 Change
Net Sales 1,146 1,391 21.4% 3,386 3,711 9.6%
Other Income 73 14 -81.3% 129 32 -74.9%
Expenditure 1,094 1,239 13.2% 3,110 3,358 8.0%
Operating Profit (EBDIT) 51 152 196.4% 276 353 27.8%
Operating Profit Margin (%) 4.5% 10.9%   8.2% 9.5%  
Interest 4 4 -18.2% 18 7 -60%
Depreciation 21 20 -2.9% 59 58 -3%
Profit before Tax 100 142 42.4% 328 321 -2%
Extraordinary items - -   0 0  
Tax 29 40 37% 122 88 -28%
Profit after Tax/(Loss) 70 101 44.7% 205 232 13%
Net profit margin (%) 6.1% 7.3%   6.1% 6.3%  
No. of Shares 15.2 15.2   15.2 15.2  
Diluted Earnings per share* 18.5 26.8   18.1 20.4  
Annualised   33.2     33.2  

The top line growth largely stemmed from its software services and systems integration businesses. CMC has been working closely with the Tata Group software major, TCS, for the acquisition of clients in the domestic as well as international markets as TCS has better reach and credibility around the globe. The joint effort of these companies seems to be paying rich dividends.

Segmental Break up
(Rs m) 3QFY02 3QFY03 %Change 9mFY02 9mFY03 Change
Customer Services 649 873 34.4% 1,838 2,145 16.7%
Systems Integration 371 428 15.3% 1,122 1,255 11.9%
Indonet 26 39 47.1% 95 133 39.4%
Education & Training 115 55 -52.4% 364 187 -48.5%
Others 57 10 -83.1% 23 95 314.2%
Total 1,219 1,404   3,442 3,816  

Only reason for concern was the IT education business. With the slowing down of the IT education segment, CMC saw a steep fall in revenues as seen for major domestic players like NIIT, Aptech and SSI. The weakness in demand for IT education is expected to continue in the near future and therefore, the company’s performance is likely to be similar in the subsequent quarters. However, company has decided not to exit from the business and wait for better times that are certain post the consolidation phase the industry witnessing. Due to the sharp down turn many branded and small time players have not been able to sustain and have gone out of business. The company in order to restructure its education business will be focusing on the IT-enabled services markets.

CMC has traditionally focused on and continues to get orders from the government of India. However, the company post divestment stands to face more competition, as the Government would now be open to considering other vendors, who are also capable of vying for projects at competitive rates. The company at its recently held analyst meet expressed its concerns on this matter. But again, given its expertise, CMC emerges as one of the strongest contenders.

A significant element of interest in CMC is due to the fact that TCS, after getting listed would be looking to merge the erstwhile PSU, along with 3 other group companies, Tata Infotech, Tata Technologies and Tata Elxsi into itself. The Government still owns 26% stake in the company for which the Tata group can approach the government after the completion of 2 years of divestment. Considering that CMC was divested in October 2001, Tata’s can approach the Government in October 2003.

At the current market price of Rs 503, the stock is trading at a P/E multiple 33x its 9mFY03 earnings. CMC performance has improved significantly post the change in management. And considering the fact that it will be using TCS marketing and domain expertise prospects look much brighter. However, neither the company’s performance in the recent past nor prospects for the future justify these steep valuations. The high price is on expectations of an open offer from the Tata as they merge CMC into is TCS. However, one needs to remember with government holding 26% of the stake negative surprises are a possible. We feel that investments on hopes of an open offer at these valuations are extremely risky.

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