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Mastek: Tread carefully

Jul 12, 2002

Mastek’s numbers at a first glance look very impressive. For 4QFY02, the company has posted a steep 15% sequential (QoQ) growth in revenues. The growth in net profits is significant at 61%. Delving deeper into the number we find a substantial part of the steep rise in net profit growth is on back of jump in other income and a drop in the depreciation figure. However, a part of the growth in net profits also stemmed from a rise in operating margins. For FY02, the company recorded a 9% growth in topline, while profits jumped by 353%. The significant growth in net profits is due to a sharp decline in the company’s write-off towards bad debts, which are included in the expenditure. Consequently, the operating margin has doubled compared to FY01. A write off of Rs 56 m towards diminution in value of investments lowered the net profit figure for FY01. However, it also needs to be noted that the company saw a steep rise in taxes, which impacted the net profit figure to a certain extent. Thus, the performance for thefiscal though not outstanding as it appears to be, is certainly a sober one.

(Rs m)3QFY024QFY02ChangeFY01FY02Change
Sales 714 818 14.5% 2,587 2,826 9.2%
Other Income 2 38 1721.6% 24 55 131.0%
Expenditure 545 612 12.3% 2,301 2,244 -2.5%
Operating Profit (EBDIT)16920622.0%286581103.5%
Operating Profit Margin (%)23.6%25.1% 11.0%20.6% 
Interest 1 4 258.5% 10 22 118.0%
Depreciation 34 21 -40.4% 123 115 -6.1%
Profit before Tax13521962.1% 177 500 182.5%
Extra-ordinary income / (expense) - -   (56) -  
Tax 30 50 65.9% 37 117 220.2%
Profit after Tax/(Loss)10517061.0%84382353.0%
Net profit margin (%)14.8%20.7% 3.3%13.5% 
No. of Shares (eoy) (m) 14.0 14.0   14.0 14.0  
Diluted Earnings per share*30.248.6 8.136.5 
*(annualised)      
P/E (X) 7.6  10.1 

While the company’s effort to improve profitability has been commendable, its performance in terms of revenue growth has been poor. The sector clocked a growth of about 22% during the fiscal. Mastek with its small size managed to clock a growth of only 9%. The company now needs to concentrate on topline growth. A steep sequential rise in revenues for 4QFY02 could be results of the company’s efforts in this direction. However, it would be wise to wait for the company to perform consistently on this front.

One of the key reasons for the company’s feeble topline growth could be the fact that it has not be able to establish itself in the largest market for software exports from India, the US. Infact Mastek saw revenues from the US geography climb down from 44% in FY01 to 25% in FY02, a decline of 37%. The concern is that while others have firmly established themselves in the US markets, Mastek needs to start all over again. However, the company claims to have added 10 strategic accounts in the US in the past year and is likely to see revenues coming in once the US economy turns around. While growth in the US is a concern, increasing competition in Europe is another concern. Finding US markets to be weak most Indian software companies are rushing to Europe that has been Mastek’s strong hold. In FY02 Mastek earned 63% of its revenues from Europe.

Among its service offerings, revenues from development services saw significant growth. In fact the contribution to the total revenues from development increased from 58% in 1QFY02 to 68% in 4QFY02. This shows sustained growth through out the year. Revenues from maintenance continued to hover around 30% in the first three quarters of the fiscal. However, in 4QFY02 revenues from this stream declined sharply and the share came down to 24% of total revenues. The numbers for FY01 is not available. Therefore yearly growth in various service offerings cannot be determined.

Among the industry verticals, financial services had one of the largest shares. The contribution to the total revenues from this industry held steady at around 27% throughout the year. The slowdown in the global telecom industry caused the share of the telecom sector to come down to 8% in 4QFY02 as compared to 14% in the first quarter of the year. Revenues from services rendered to government increased from 20% in 1QFY02 of the year to 32% in 4QFY02. Mastek is working on projects for Governments in the US, UK and India. In the US, Mastek was chosen to customize the solution on ‘Uniform Commercial Code and Business Entity Solutions’ by NIC, a leading Government vendor. In UK, Mastek has worked on a number of applications for the Government along with its strategic alliance partner. These include London traffic management, Connexions smartcard and Criminal Records Bureau. Revenues from manufacturing also declined steeply during the fiscal.

Highlight of the performance and perhaps the strongest positive with Mastek is the joint venture with Deloitte consulting. The JV accounted for Rs 46 m (2% of the revenues) in FY02. The joint venture at present has 12 clients. This could be an area of strong growth going forward. Mastek added 4 new clients in 4QFY02, taking the total number of active clients to 72. The total number of clients added during the year is 29.

The company expects revenues to grow by 45% to 50% in FY03. While the net profits are expected to grow in the range of 42% to 52%. One growth driver could be growth in revenues from the US geography that are on the lower side. At the current market price of Rs 370, the stock is trading at a P/E multiple of 10x its FY02 earnings. While the guidance looks very impressive, retail investors should wait for the company to deliver.

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