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CMC: 'Extraordinary' impact!

Mar 14, 2006

Introduction to results
TCS' subsidiary, CMC had recently announced results for the third quarter ended December 2005. For 3QFY06, the company reported a disappointing performance in the topline, due to subdued performances of its key business segments. However, margins remained flat during the quarter. This quarter, as was the case in the previous quarter as well, substantially higher other income resulted in net profit growing at a strong pace. However, this time again, the rise in other income was due to an extraordinary item. For the nine-month period, the performance has not been too enthusing either.

Financial performance (Consolidated): A snapshot…
(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Sales 2,139 2,073 -3.1% 5,872 6,092 3.8%
Expenditure 2,016 1,953 -3.1% 5,329 5,760 8.1%
Operating profit (EBDITA) 123 121 -2.0% 543 332 -38.9%
Operating profit margin (%) 5.8% 5.8%   9.2% 5.4%  
Other income 21 46 118.3% 39 279 623.5%
Interest 13 9 -28.7% 29 26 -11.0%
Depreciation 22 25 11.7% 64 67 5.2%
Profit before tax 109 132 22% 488 517 6.0%
Tax 12 11 -7.9% 75 131 75.3%
Extraordinary items - -   - -  
Profit after tax/(loss) 96 121 25.3% 413 386 -6.6%
Net profit margin (%) 4.5% 5.8%   7.0% 6.3%  
No. of shares 15.2 15.2   15.2 15.2  
Diluted earnings per share* (Rs)         14.6  
P/E ratio (x)*         35.6  
* On a trailing 12-month basis.            

What is the company's business?
CMC is a 51% subsidiary of TCS Ltd. and is organised around four strategic business units (SBUs). The first is the Customer Services Division (55% of consolidated revenues in 3QFY06), where the company provides services like infrastructure development and management, networking management, third party maintenance and networking consultancy. The Systems Integration Division (35%) is involved in activities like software development, maintenance and systems consultancy. The ITES Division (4%) has offerings like data management services, facilities management, web design, hosting and electronic data interchange (EDI). Finally, the Education & Training Division (6%) offers IT education and training through the company's own and franchisee centres. Some of the key projects the company has been involved in the past include BOLT (for BSE), FACTS (a fingerprint identification system) and IMPRESS (ticketing and reservation system for Indian Railways).

What has driven performance in 3QFY06?
A sense of déjà vu: In 3QFY06, CMC's key business segments, i.e., Customer Services and Systems Integration, recorded disappointing performances. In fact, the Customer Services segment, which contributes over half of CMC's consolidated topline, saw a 12.7% YoY decline, resulting in its share in topline declining from 60.3% in 3QFY05 to 54.8% this quarter. The Systems Integration segment's revenues were flat, declining slightly by 0.2% YoY.

However, the other 2 segments of the company, i.e. ITES and Education & Training, put in robust performances. The ITES segment grew at an impressive 87.6% YoY, while the Education & Training segment grew at a strong 59.2% YoY. This has been the second successive quarter in which the ITES segment has shown good traction and is a positive for CMC, given the fact that the Indian ITES-BPO industry has been amongst the fastest growing. The Education & Training segment had also grown by nearly 50% YoY last quarter, thus, this consistency is a big positive for the company.

The segmental picture…
  3QFY05 3QFY06 Change
  Rs m % of total Rs m % of total %
Customer Services 1,297 60.3% 1,132 54.8% -12.7%
Systems Integration 735 34.2% 733 35.5% -0.2%
ITES 45 2.1% 84 4.0% 87.6%
Education & Training 73 3.4% 116 5.6% 59.2%
Total revenues* 2,149 100.0% 2,065 100.0% -3.9%
* Excludes unallocable revenue

Margins stable: CMC managed to record a marginal 7 basis points rise in operating margins during 3QFY06. The major cost head, materials, fell to 38.2% of sales in 3QFY06 as compared to 49.3% in 3QFY05. This was the major reason for the cost control seen this quarter.

The PBIT performance of the segments of the company was mixed. The Systems Integration and Education & Training segments saw impressive PBIT expansion, while Customer Services and ITES witnessed margin erosion. The continuing good PBIT performance of the Education & Training segment from the last quarter is a heartening feature for CMC.

Extraordinary item powers bottomline: As was the case in 2QFY06, an extraordinary item of profit on the sale of land and residential properties saved the day for CMC this quarter as well. The company earned an income of Rs 40.3 m from this source, thus, resulting in other income soaring to the tune of over 118% YoY. This, coupled with a considerably lower effective tax rate, sent the bottomline soaring by 25% YoY during the third quarter. The performance for the nine-month period has not been too impressive.

What to expect?
At the current price of Rs 519, the stock is trading at a price to earnings multiple of 35.6 times its trailing 12-month earnings. This quarter, continued traction in the ITES business and consistent performance of the Education & Training business has stood out for CMC. The major factor in the future will be whether the company can sustain this growth. CMC needs to now focus on maintaining consistency of revenue growth, as its major segments, i.e., Customer Services and Systems Integration, have been fairly inconsistent and given CMC's dependence on these 2 segments (over 90% of revenues in 3QFY06), the company has to get its act together.

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