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CMC: Globally inclined!

Oct 19, 2004

CMC had recently announced its results for the quarter and half year ending September 2004. For 2QFY05, while the company reported a YoY dip in the topline, profits grew strongly on the back of improvement in operating margins. Profit growth could have been stronger but for a substantial drop in other income.

Financial performance (Consolidated): A snapshot…
(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
Sales 1,887 1,832 -2.9% 3,586 3,732 4.1%
Expenditure 1,789 1,645 -8.1% 3,354 3,313 -1.2%
Operating profit (EBDITA) 98 187 91.5% 232 420 80.9%
Operating profit margin (%) 5.2% 10.2%   6.5% 11.2%  
Other income 46 9 -81.4% 62 18 -71.5%
Interest 9 9 8.6% 16 16 -0.6%
Depreciation 23 22 -7.4% 43 42 -4.2%
Profit before tax 112 165 46.9% 234 379 62.1%
Tax 45 35 -21.5% 81 63 -22.6%
Profit after tax/(loss) 67 129 92.6% 153 317 106.8%
Net profit margin (%) 3.6% 7.1%   4.3% 8.5%  
No. of shares 15.2 15.2   15.2 15.2  
Diluted earnings per share* (Rs) 17.7 34.2   20.2 41.8  
P/E ratio (x)   20.7     16.9  
(* annualised)            

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 (60% of consolidated revenues), where the company provides services like infrastructure development and management, networking management, third party maintenance and networking consultancy. The Systems Integration Division (33%) is involved in activities like software development, maintenance and systems consultancy. The ITES Division (3%) has offerings like data management services, facilities management, web design, hosting and electronic data interchange (EDI). Finally, the Education & Training Division (4%) offers courses in IT 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?

System integration pares topline decline: While topline witnessed a YoY decline in 2QFY05, the systems integration business was the best performer for CMC. Revenues from this business grew YoY by 7% and contributed to around 33% of the company’s 2QFY05 revenues. Revenue growth of 50% YoY from the education and training business also helped pare topline decline in the quarter. What is intriguing, however, is the fact that revenues from the ITES business declined 23% YoY despite the fact that this segment has been amongst the best performers for almost all Indian software companies.

Based on geographies, CMC’s international business revenues (24% contribution to the topline) grew 44% YoY in 2QFY05 while domestic business revenues (75%) declined by 11%. The company has been able to well leverage its parent TCS’ brand name and reach in global markets and this is seen in improvement in international revenues in the quarter. As a matter of fact, in 1QFY05, while domestic revenues grew YoY by 6%, international revenues were up 62%.

Lower costs aid margins: Lower cost of materials was the main reason for improved operating margins in 2QFY05. As a matter of fact, cost of materials declined (as a percentage of revenues) from 53% in 2QFY04 to 42% in 2QFY05. Margin improvement was however pared by a rise in share of onsite revenues to 48% (from 44% in 2QFY04). This then led to a rise in staff costs and overseas living costs. The improvement in margins was seen across all the four segments (see chart below).

Margin improvement aids net profits: Factors like improvement in operating margins and a lower tax outgo have helped CMC post strong net profit growth during both 2QFY05 and 1HFY05. This growth in profits, however, could have been better but for a substantial YoY decline in other income.

What to expect?
At the current price of Rs 708, the stock is trading at a P/E multiple of 16.9 times annualised 1HFY05 earnings, which is at the higher end of the valuation spectrum. While the company’s poor performance in customer services and ITES businesses is a cause of concern, it is important to note that the company has managed to improve its revenues from the high-end systems integration business. Also, the fact that CMC is gradually moving from being just a third-party maintenance services and equipments provider towards a high-end software services and solutions provider, should help the company grow strongly in the future, especially when it has been successful in leveraging the brand name and reach of TCS in global markets.

Finally, while the overall long-term prospects for the company look encouraging, high valuations increase the risk profile of the stocks.

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