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3QFY11 results
With the set-back from failed telecom investments already priced in, the
street was looking for improvement in Mindtree’s core business metrics
for the next stock trigger. However, 3QFY11 results failed to provide the
much needed respite with 3.5%QQ $-revenue growth and 15.4% Ebitda
margin in the core business much below expectations. Mindtree’s weak
3Q11 revenue and margin performance sets the roadmap for rest of 2011
for Tier-2 companies – higher than 2010 revenue growth with eroding
margins. In our view, the steep valuation discount of Mindtree and other
Tier-2 Indian techs to Tier-1s is reflective of their inability to convert the
strong demand environment into earnings growth. Underperform stays.
Revenue trajectory substantially below sector average
3.5%QQ growth in $-revenues to US$85.25m came materially below our and
street expectations. Revenue in 3Q was also boosted by a licensing fee of
US$0.6m. A 4.9%QQ decline in the product engineering services was the key
drag on the revenues even as IT services growth came in strong at 7.6%QQ.
Flux in product engineering is attributable to loss of one major customer by
Kyocera’s India unit (acquired by Mindtree in late 2009). While management
commentary on 2011 revenue prospects was positive, we remain wary of
Mindtree’s ability to fully capitalise on the demand upswing.
Subdued core margins. No catalysts for immediate improvement
Reported Ebitda margins of 11.7% were impacted by US$3.2m of restructuring costs associated with winding down of the telecom products
business. Excluding the one-off charges, Ebitda margin was 15.4%, lowest in
the last 5 years. While Mindtree has ruled out any wage hikes before its
normal cycle (Apr-Jul), 25%+ attrition for the second consecutive quarter
worries us and we will not be surprised if Mindtree is forced to make some
interim wage corrections. Moreover, margin improvement from current levels
demands significantly higher topline traction, which will likely remain a
challenge for Tier-2 techs like Mindtree.
No fundamental drivers as financials likely to remain inferior
Through 2010, Mindtree’s financials have trailed sector peers materially as it
has been pre-occupied with first ramping-up the telecom business and then
winding it up. Post the telecom mishap, winning back investor confidence is
now contingent on consistent financial performance. 3QFY11 results indicate
that Mindtree has some more way to go on that front. Revenue growth in
early 20s is unlikely to be enough to manage margins amid the rising wage
inflation. We see no fundamental catalyst for the stock. We are cutting FY12-
13 earnings by ~1% and maintain a negative bias on the stock.
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