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MindTree – Impressive Margins in FY2012 – Sustainable ? Differing Valuations

April 19, 2012

MindTree reported modest results for 4QFY2012, with OPM and PAT coming in ahead of expectations. The company reported a 4.9% qoq increase in volumes. MindTree reported revenues of US$105m (+1.3% qoq, +22% yoy). EBIT margins surprised positively and improved to 15.5% (+161bps qoq, +895bps yoy). Net income grew to Rs689m (+14% qoq, +115% yoy).

Management Outlook: While the recent weeks saw deterioration in the spending environment and management expects lacklustre growth for 1HFY13, it sees a robust pickup in 2H. Our interactions with the management indicate that it has not seen any project cancellations. It also expects to grow faster than the industry, with close to double-digit growth in its product engineering [35% of Business] business and and expects IT services [65% of Revenue] to grow at slower rate in FY13

Hiring Hiring was muted, at ~60 employee additions. Management is confident that its IT services business would continue its momentum and has given offers to 3,000 campus graduates for FY2013, who are expected to join from May 2012. MindTree expects the wage hikes to be lower than last year will be finalized by May-15th.

MindTree Bulls Vs Bears:
Bulls argument,

Since the leadership changes and reorganisation, Mindtree has consistently improved margins and registered robust revenue growth from IT services.

It is a company with good quality management and governance, its top clients are scaling up nicely, the product engineering business (which was a drag) is stabilizing, margins are expanding off a low base and valuations are attractive.

The string of steady quarters and more importantly, good improvement in underlying business metrics, has the stock ripe for a re-rating.

Bears Argue as follows,

Based on the 3,000 campus hires and likely single-digit growth in product engineering (PES, 33% of rev), MindTree is headed for low-teen growth.

Mindtree has a higher proportion of application development work (~40% of revenues), so risks are higher given global macro economic uncertainties.

Valuation of 8x is in line with mid cap IT Services multiples and factors in management’s decision to enter and then exit the telecom products business within a short span of time. With the Founder and Chairman deciding to move on from MindTree some time back.

Financials:
According to various Research entities here is MindTree’s EPS and Target Price for FY 2013
Angel – Rs 54 and Target of Rs 585
IIFL – Rs 61 and Target of Rs 648 [Too Bullish]
Kotak – Rs 59 and Target of Rs 590
BNP Paribas – Rs 55 and Target of Rs 420 [Bearish]
Citigroup – Rs 53 and target of Rs 420
Credit Suisse – Rs 59 and Target of Rs 600
Morgan Stanley – Rs 53 and Rs 565.

The Stock at Rs 530 appears to be Fully Valued around Rs 550 and any upside fro mthere should be used to Boo kProfits if already existing in your Portfolio.

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