Accumulate CMC - Motilal Oswal

We are recommending ACCUMULATE on CMC Limited with a target of Rs 2100 in next 12-15 months.Aggresive growth in international revenues, coupled with a good domestic focus on business and steady free cash flows deserves better valuations as compared to IT mid cap space in India. While there is good value in the stock at Rs 1900, the stock has run up sharply in the last one month.The margin of safety would be higher if the stock is added aggresively to portfolios at correction of 5-10%. Turnaround over, focus shifts to growth:

CMC Limited has historically been in business of low margin equipment reselling.Management focus changed towards increasing the high margin services business after acqisition by TCS in 2001. As a result, company's total revenue has largely remained flat over the last 5 years whereas services business revenue has grown at a CAGR of 12%. International revenues grew at a CAGR of 15% during the last 5 years till the end of FY2010, which is now growing at a rate of ~10% every quarter for the last four quarters with a reported annual growth of 47% in the in the Q1 of FY2011. Faster growth in international business augurs well for the company as the operating performance is directly correlated with growth in international business.

Good play on domestic IT services opportunity: The company draws around 50% of its total revenues from domestic business including equipment reselling.There are very few IT services companies in India, which have this kind of domestic focus in their business operations. As per IDC estimates, India's domestic IT and ITeS market excluding hardware is slated to grow at a rate of 20% CAGR during 2008-2013 to `103,032 Crores. Focus on domestic business reduces overall vulnerability of company's business to international environment, which augurs well for the company's prospects in the long run.

Dependency on TCS: The company is a 51% subsidiary of TCS and draws ~42% of revenues from it, which has increased to this level from 17% during FY05. This kind of sales arrangement has both its advantages and disadvantages. The company does not have to invest in its own marketing and sales infrastructure to fetch business from overseas, which reduces overall cost of delivery for the company whereas CMC pays a marketing margin to TCS for the business via this arrangement. On the other hand any kind of adverse development on TCS' business prospects will be detrimental for this company's prospects too. We have a NEUTRAL rating on TCS and our estimates suggest ~ 17 % growth in topline and ~16% in bottomline for TCS.

Source : Equity Bulls

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