MindTree - Margins surprise, Valuations attractive, Re-iterate Buy - Sunidhi

MindTree results were better than our expectations operationally, while maintaining a decent demand growth environment for its IT services. In Q2FY13, the revenues of MindTree grew 5.9% QoQ (in INR terms) and 1.7% QoQ (in USD terms), while growing 2.1% in constant currency terms. Volume growth of 1% QoQ, while pricing saw an increase of 0.5%. EBITDA margin increased by 127 bps QoQ on rupee depreciation and operational efficiencies and was higher-than-expected.

Growth forecast lowered, but company maintains healthy growth for H2FY13 Management expects company to show a lower than industry growth rate of less than ~11%. We believe MindTree would grow revenue at a CQGR of 3-3.5% in the IT services segment over the coming quarters. IT Services grew 0.9% QoQ in Q2FY13 (primarily due to ramp down in one of the large project in the Travel vertical). PES part of the business is expected to show lumpy growth in the semiconductor and telecom business, while the other verticals are expected to show growth. In this quarter, PES business was up 3.2% QoQ due to ramp-up in large deals won in the previous quarters.

Operational Metrics improves: 1) Salary hike for 80-85% of the employees already taken in Q2FY13, remaining to be taken in Q3FY13. 2) EBITDA margin break-up: +140bps from Forex movement, +250bps from operational efficiencies, (-) 180bps from salary hikes and (-) 80bps due to branding during the quarter. 3) Margin outlook - Impact of the remaining wage hike will be a ~80-100bps - headwind for margins; Management expects flattish EBITDA margins in Q3. 4) Despite longer cycle time for decision making, clients have not cut pricing or IT budgets or cancellation of projects. 5) Onsite volumes/revenues grew 4%/4.6% QoQ, indicating ramp-up in new projects. 6) US and Europe grew at 1.7% and 3.4% QoQ, respectively. 7) BFSI and Manufacturing, both grew ahead of company average, at 6.3% and 3.2% QoQ, respectively.

High cash holdings provides strong downside cushion. 1) Cash and cash equivalents of Rs.4.4bn (translating to Rs.107/share, 15.8% of Mcap in cash) as on Jun-12. 2) DSO was stable at 73 days. 3) Hedge position of US$136m (US$82 mn for FY13 @ Rs.52.07/US$ and US$54 mn for FY14 @ Rs.57.72/US$). 4) Company is currently making investments in front end to win large deals. 5) Headcount increased by 53 QoQ to 10,883.

Valuation: We maintain our "BUY" recommendation on MindTree with a target price of Rs.820 per share, implying a target multiple of 10xFY14E EPS. Risks: As MindTree is aggressive in acquiring companies to plug its offerings, the issues pertaining to integration/scale-up could hurt going forward.

Source : Equity Bulls

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