BofA Merrill Lynch:: Mastek- Muted order intake levels; Retain Underperform

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Mastek 
   
Muted order intake levels; 
Retain Underperform 

„Underperformance to continue
Mastek reported disappointing 2Q results, with a net loss of Rs106mn vs. our
estimate of a loss of Rs95mn. Fresh order intake declined 13% QoQ, post a 19%
QoQ decline reported in the previous quarter, and remains a key concern for the
stock. Given exposure to project-based revenues (~65%), muted order intake
during the quarter and a high cost structure, we believe that margin recovery is
likely to be prolonged. We retain our estimates and PO of Rs190, and retain our
Underperform rating on the stock.

2Q: losses continue, albeit lower than 1Q.
Mastek reported 1% QoQ growth in revenues, missing BofAMLe by 3%. EBIT
Margins stood at negative 7.6% vs. -11% in 1Q and in line with our estimate.
Margin expansion was driven by cost benefits from a decrease in employee
headcount and tighter cost-control measures. The recurring loss stood at
Rs106mn vs. our estimate of loss of Rs95mn.
Plans to increase share of services & enter new verticals
On the call, management highlighted that it intends to increase its share of the
services pie (~30% currently) and plans to add a few more verticals. It currently
has high exposure to the Healthcare & Government segment.
Muted order intake; revenue visibility remains an issue
Order backlog declined by 5% QoQ during the quarter and remains one of the key
concerns for the stock. Given a high exposure to project-based revenues, the
recovery in the order book is likely to lag IT peers. While it won a deal from the
UK government through a partnership with a local system integrator, we believe a
meaningful recovery in order intake would be required for the stock to rerate.


Price objective basis & risk
Mastek (MSKDF)
Our PO, at Rs190, is at 6x EV/EBITDA FY12E, at the lower end of the mid-cap
band of 6x-9x. We believe the low multiple is fair, given i) the higher risk to
estimates, given that 60% of revenue is linked to discretionary spending, and ii)
low revenue visibility, given the significant decline in the order book over the last
4 quarters.
Upside risk: a large order win that would refill the NHS ramp-down revenue loss
and deal wins for the Elixir platform from the US market. Downside risks: high
exposure to discretionary spending, given that nearly 60% of revenue comes from
development work, risk from adverse currency movement.