Mindtree - Margin beat and raise cycle seems to be over! - ICICI Securities

Even as consensus called out the margin peak several times, we believed otherwise (refer - 'Can margins surprise further?' and 'Margin has not yet plateaued'. Potential for further margin surprise was the key rationale behind our earlier BUY rating. Besides transient Covid-led tailwinds, Mindtree's margin expansion was aided by sustainable and structural changes in costs. While we expected parity with cost structure of LTI by FY23E, the convergence has happened earlier! As some of the operational metrics (e.g. utilisations, salary costs) recalibrate towards their new normal, margins are more likely to contract (than be stable or increase). Incrementally, as investor focus shifts from mere cost structure correction to growth, we see limited margin of safety for disappointments given the favourable FY21 base. Post our reinitiation of coverage in Oct-20 with a BUY rating, the stock price was up ~25%. As we reach the fag end of company-specific tailwinds and turn cautious on the sector (detailed in our earlier note), we downgrade Mindtree to ADD (from BUY).

- In-line revenues, robust beat on margins; surprisingly lower salary costs: Revenue growth (4.6% QoQ, CC) was slightly ahead of our estimates. Growth was broad-based across all key geographies - US, Continental Europe, UK and Ireland. Barring BFSI, which remained largely stable, growth across verticals too was broad-based. Sequentially, EBIT margins improved ~290bps and were ~220bps ahead of our estimates. This was majorly due to two factors:

Firstly, utilisations (including trainees) witnessed ~430bps QoQ improvement as the company catered to some of the incremental demand through reskilling existing workforce, rather than hiring new talent. Secondly, as is the case with rest of the industry, Mindtree too had seen the benefit of incremental project ramp-ups happening largely offshore due to restricted travel.

Secondly, overall employee benefit expense sequentially remained considerably stable (at Rs12.6bn). However, it is key to note that employee salary costs declined by ~Rs640mn even as EOP headcount increased (by 370). We await further clarity from the management on this aspect.

- Management expects industry-leading growth and >20% EBITDA margins: Total Contract Value (TCV) of deals booked during the quarter was healthy at US$312mn (vs US$303mn in Q2FY21). Management hinted at an aspiration for industry-leading growth. In addition, the company also hinted at >20% EBITDA margins in the near future (vs 23.5% in the Dec-20 quarter). Incremental hiring, consequent recalibration of utilisations (to 81-82% levels from 83.1%, includes trainees) and impending wage hikes are some of the foreseeable margin headwinds. On the other hand, management also hinted at further margin levers that can absorb some of the aforementioned headwinds.

- Fag end of company-specific tailwinds! Downgrade the stock to ADD: While we expected a parity with cost structure of LTI by FY23E, the convergence happened earlier! As some of the operational metrics (e.g. utilizations, salary costs) recalibrate towards their new normal, margins are more likely to contract (than being stable / increase). Incrementally, as investor focus shifts from mere cost structure correction to growth, we see limited margin of safety for disappointments given the favorable FY21 base.

As we rebase our exchange rate assumptions and reset our expected growth / margin trajectory, our EPS estimates over FY21E-FY23E witness 3-6% downward revisions. At our revised estimates, the stock is trading at 23x 1-year forward P/E (~56% above pre-Covid averages). Post we reinitiated coverage in Oct-20 with BUY rating, stock was up ~25%. As we reach the fag end of company specific tailwinds and turn cautious on the sector (detailed in our earlier note), we downgrade the stock to ADD (vs BUY earlier).

Shares of MINDTREE LTD. was last trading in BSE at Rs.1680.3 as compared to the previous close of Rs. 1660.6. The total number of shares traded during the day was 176604 in over 13549 trades.

The stock hit an intraday high of Rs. 1759.7 and intraday low of 1665.15. The net turnover during the day was Rs. 301668740.

Source : Equity Bulls

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