Buy MindTree; target Rs 1087: FinQuest Securities

FinQuest Securities is bullish on MindTree (MTCL) and has recommended buy rating on the stock with a target price of Rs 1,087 in its February 8, 2013 research report.

"MTCL, reported revenues of $110mn up 2.4% sequentially but below our expectations (3.5% Q-o-Q). In rupee terms, revenue declined 1% sequentially to Rs5.9bn, in line with our expectations (down 1.3% Q-o-Q). Volumes declined 0.7% sequentially, however realizations improved by 3.3%. Among the business segments, it was IT Services (ITS) that out-performed, growing 4.8% sequentially in dollar terms, mainly due to a 8.4% Q-o-Q growth in travel, media and services verticals (Q2 was muted due to projects coming to an end in the Travel vertical) while Product Engineering Services (PES) business was quite muted posting a negative growth of -2.7% sequentially due to client shut downs.

Volumes declined 0.7% sequentially, which was expected due to seasonal factors, while it was offset by a 3.4% improvement in realization. The higher productivity during the quarter was driven by greater efficiencies in fixed price contracts as revenue contribution from fixed price contracts which increased by 350bps Q-o-Q to 42.3%.

EBITDA margins of MTCL contracted 204 bps sequentially to 20.1%, on account of wage hikes given to ~20% of employees and rupee appreciation 3.4% (margin sensitivity ~40-50bps per point change in INR/USD). However, Gross margins improved marginally to 40.2% on the back of an improvement in realization. MTCL has invested this savings into higher S,G&A as management expects the demand scenario to improve going into FY14.. Higher-than-expected forex gains of Rs142mn (versus Rs415mn loss in the previous quarter) aid the sequential profit growth of 36.8% to Rs 988mn.

Over the last seven quarters, the revenue run-rate has been flat for PES. The slowdown in the semiconductor sector coupled with lower discretionary spend over the past year were the main reasons for this subdued performance. However, MTCL has been able to improve the profitability of the PES segment (~24% in Q3FY13 vs. ~7% in Q1FY12) while the outlook looks good as the discretionary spend is set to pick-up.

MTCL has a higher leverage towards discretionary spend as it derives ~45-50% of its revenues from discretionary projects which was construed as negative for MTCL in the past in the deteriorating macro environment. But the same factor would be beneficial for MTCL as the companies' increase their discretionary spend.

MTCL delivered a decent set of numbers in spite of a seasonally weak quarter. It benefitted from higher pricing while it has also increased the spend on S,G&A to cash in on the pickup in discretionary spend going ahead. The company should benefit from the improvement in the discretionary spend thus aiding the performance of the PES segment while cost optimization should be retained in the improving demand scenario. Taking the above factors into account we model for FY13 and FY14 revenue and EPS to come in at Rs 23.62bn & Rs 25.30 bn and Rs 82.6 & Rs108.7 respectively. With FY14 hedges coming in at Rs 57.37 the company could benefit from forex gains in FY14 if the current rate of Rs 53.5/$ sustains while it could slightly lose out on the INR topline and margin front. We reiterate our Buy rating on the stock and roll forward our target price for FY14 at Rs 1,087(up from 737 for FY13E) valuing the company at 10x FY14 earnings of 108.7 (factoring the forex gains)," says FinQuest Securities research report.

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