Mindtree - Revenue Below Expectations, Forex Loss Batters Net Profit - Nirmal Bang

Mindtree's 3QFY14 US dollar (USD) revenue grew 2.5% QoQ at US$127mn, 1.2% below our estimate. Volume growth stood at 2% QoQ, while blended pricing rose 0.6% QoQ owing to favourable cross-currency movement. From a vertical perspective, BFSI (banking, financial services and insurance) and travel & transportation verticals witnessed good growth at 5.4% and 5.2%, respectively, in USD terms. Owing to furloughs, hi-tech witnessed a 2.9% QoQ revenue decline. Rupee revenue grew 2.7% QoQ at Rs7.9bn. Margins fell 127bps QoQ owing to wage hike impact (93bps/23bps below our/Bloomberg consensus estimates, respectively). Owing to a forex loss of Rs272mn (gain of Rs200mn in 2QFY14), net profit fell by a steep 31.2% QoQ, at Rs885mn (22.9%/14.1% below our/Bloomberg consensus estimates, respectively). We have retained Sell rating on Mindtree with a revised target price of Rs1,386 (Rs1,218 earlier), as we roll over to FY16 earnings. We have factored in a 13% USD revenue growth, flat margins and 11% earnings growth for FY16E.

Volume growth slows, hi-tech weakens on furloughs: Mindtree posted a 2.5% QoQ growth in 3QFY14 USD revenue (US$127mn, 1.2% below our estimate of US$128.6mn). In rupee terms, revenue grew 2.7% QoQ at Rs7.9bn, 1.2% below our estimate and in line with Bloomberg consensus estimate. In 3QFY14, it was the BFSI and travel & transportation verticals that outperformed, up 5.4% QoQ and 5.2% QoQ, respectively. Volume growth stood at 2% QoQ, with on-site volume growth at 1.3% QoQ, while offshore volume growth was at 2.2% QoQ. Owing to favourable cross-currency movement, reported pricing was up 0.6% QoQ, with on-site billing rate up 4.7% QoQ while the offshore rate was down 1.9% QoQ.

Wage hikes and investments prune margins, while forex loss batters net profit: Mindtree posted a 127bps QoQ fall in EBITDA margin (93bps/23bps below our/Bloomberg consensus estimates, respectively), mainly owing to wage hikes and investments in the business. SG&A optimisation prevented a further margin decline. A forex loss of Rs272mn (forex gain of Rs200mn in 2QFY14) led net profit to come in 31.2% lower QoQ at Rs885mn (22.9%/14.1% below our/Bloomberg consensus estimates, respectively).

Lower margin despite revenue growth is disappointing, retain Sell: While Mindtree's revenue growth has been impressive (14.3% YoY USD revenue growth in 9MFY14), its performance on the margins front has been less than impressive, with 9MFY14 EBITDA margin down 154bps YoY. Had it not been for rupee depreciation, the decline in margins would have been even steeper. Lack of upward movement on employee utilisation is also a disappointment. Mindtree plans to make further investments in the US and in operational efficiency and sales efforts, while employee utilisation is likely to improve only after a couple of quarters. Thus, any major upward movement in margins is unlikely. We are also not comfortable with the forex-led nature of earnings growth in 9MFY14 (adjusted for forex gains, earnings up just 6.8% YoY). The doubling of stock price over the past one year also does not provide comfort on further upside. We have retained Sell rating on Mindtree with a revised TP of Rs1,386 (Rs1,218 earlier), as we roll over to FY16 earnings. We have factored in a 13% USD revenue growth, flat margins and 11% earnings growth for FY16E.

Source : Equity Bulls

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