Mastek: As dull as ditchwater!

Mastek announced its FY04 results yesterday. While the company has reported a good performance for the fourth quarter, its full year performance continues to speak an appalling story. While the management of the company has indicated improved times in FY05, we are apprehensive considering the company's performance over the past years.

What is the company's business?
Mastek is a second-tier software company with offerings in areas like application development (68% of revenues) and maintenance (29%) and implementation (3%). The company derives the largest chunk (42%) of its revenues from the financial services vertical.

What has driven performance in 1QFY05?

• Sales: Growth in company's FY04 sales is a result of growth (20% YoY) in its maintenance services segment.On the other hand, all its other segments, viz. software development, products and implementation have witnessed decline in revenues. This is in contrast with other Indian software companies that have been able to grow revenues from these streams on account of an improving global demand for new software and implementation work. In this context, Mastek's performance seems concerning.

• Operating margins: The substantial decline in operating margins witnessed in FY04 is a result of an increase in staff costs. As a matter of fact, staff costs as percentage of revenues have increased from 54% in FY03 to 61% in FY04. The company has hired a net of 586 employees in FY04, growth of 32% over the manpower base of 1,824 in FY03. This sedate addition to the employee base is in itself indicative that the company is not anticipating much demand for its services going forward as well.

• Net profits: The substantial decline in Mastek's FY04 net profits has been perpetrated by a relatively higher growth on the expenditure front while its topline growth remains dull. This is highly concerning because if this were to continue going forward, returns to investors will be impacted severely.

What to expect?
At the current price of Rs 276, the stock is trading at a P/E multiple of 13x FY04 earnings. Looking at the company's FY04 performance, it seems that investors need to adopt a cautious approach towards investing in the stock. While the management has indicated that it will be able to maintain its fourth quarter performance, we are apprehensive considering the past track record of the management and its inability to growth the existing businesses.