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CMC: Buy
Pick up in the high-margin services component has resulted in top-line expansion too.
K.Venkatasubramanian
Spending on IT hardware and software by Indian companies and the government is picking up at a rapid pace. Globally too, technology spending is reviving, especially in the US, after a lull of two years. The few companies that operate in this space could benefit from the momentum.
Investors with a two-year horizon can consider buying the shares of CMC, a company that provides system integration and IT applications services, in the light of its strong positioning in the domestic and American markets. At Rs 2,498, the share trades at 16 times its likely FY-12 per share earnings. Although this is at a slight premium to mid-tier IT players as well as its peers such as HCL Infosystems, a refocused business mix which has helped the company register superior margins (around 20 per cent at operating level) and enhanced profitability, justifies the premium. Over the last couple of years, the company has reduced its focus on hardware- intensive deals that generate lower margins in favour of high-margin services contracts. Though this had a negative effect in terms of decline in revenues, it has had a positive effect on margins. Now, with the services component too having picked up significantly for CMC, the company is seeing top-line expansion as well.
In FY-10, CMC's revenues fell 7.4 per cent to Rs 870.7 crore, while net profits expanded by 23.3 per cent to Rs 143.3 crore. In the first half of the current fiscal, the company witnessed a 20 per cent increase in revenues to Rs 515.2 crore, while net profits zoomed by 43.7 per cent to Rs 90 crore.
Healthy business-mix
From being heavily hardware-intensive, the service offerings of CMC have evolved considerably. It now derives over 90 per cent of its revenues from services deals with pure hardware contracts accounting for the rest. The change in focus has meant that system integration deals, that contribute 53 per cent of the overall revenues and the ITES (IT Enabled Services) division, which manages IT applications and provides document digitisation services (over 16 percent of revenues) are main revenue contributors. These two divisions generate EBIT margins of over 30 per cent.
CMC has expanded its client base significantly over the last couple of years. International revenues now account for over 55 per cent of overall revenues and is growing at a healthy clip, outpacing even the domestic business' growth rate.
In this regard, its association with TCS (of which it is a subsidiary) has helped considerably in terms of both client references and also winning deals . Despite a higher proportion of overseas revenues, much of these projects are executed in India, which means that costs are considerably optimised.
Strong government clientele
Domestically, CMC derives 33-34 per cent of revenues from the government sector, where spends on areas such as rural connectivity, and e-governance is increasing rapidly. Among others, clients include entities such as Indian Railways and the Election Commission where heavy volume of data is likely to make a sustainable business case for the company.
With a more services approach and contracts being signed for longer time-frames of three-five years, there is significant scope for cost efficiency. Nearly 37 per cent of the company's employees are on contract making for a flexible resource base. Longer tenure contracts also significantly increases revenue visibility. Of course, becoming more and more service-oriented means that CMC would compete with mid-tier IT companies. But with the TCS channel available and its superior expertise in managing hardware, CMC is well-positioned to make inroads into areas such as remote infrastructure management. Competition in the system integration space from Wipro Infotech and HCL Infosystems is another risk.
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