MindTree Ltd.
Raise PT and earnings
estimates; maintain OW
What's Changed
Price Target Rs565.00 to Rs765.00
F13e and F14e EPS Up by 23% and 21%
Despite slower revenue growth in PE services and
moderating revenue growth in IT services, we still
expect 14% yoy US$ revenue growth overall. We
factor in rupee gains and raise our EPS estimates;
our PT rises to Rs765. We believe stronger than
expected US$ revenue growth could trigger
re-rating.
Management expects to deliver higher than industry
revenue growth in F13e: After flattish revenues in PE
services in F12, management expects single-digit
revenue growth in F13e. In IT services, management
indicated that the pipeline remains strong; however,
conversion is taking longer. Cross-currency movements
could eat into 1Q US$ revenue growth by 100 to 150 bps
qoq, in our view. We forecast US$ revenue growth of
~14% yoy in F13e, in line with NASSCOM forecasts for
industry growth.
Margins hold upside in F13e: MindTree has deferred
wage hikes from April to the month of June. Deferral of
wage hikes and steep rupee depreciation so far should
help margins for 1Q. Management expects to improve
margins by another 100 to 150 bps yoy in F13 and any
currency impact should further add to margins. Given
strong rupee depreciation, we believe margins could
surprise positively in F13e. We have assumed the
benefit of rupee depreciation to EBIT margins (~13.7%,
+200bps yoy) in F13e at Rs52.5/US$.
Valuation looks attractive: We have raised our
earnings estimates by 23% for F13e and 21% for F14e
on improved margin assumptions. The stock is currently
trading at ~9-10x our revised estimates vs. earnings
CAGR of 15% over F12-14e.
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We remain Overweight on MindTree; our new price target is Rs765
We think strong earnings growth could spur further
outperformance
MindTree stock has strongly outperformed YTD – up 56% vs.
the 6% gain in the Sensex 6%). Over the last few quarters,
MindTree has continued to surprise positively and delivered
earnings ahead of expectations, leading to increased
estimates.
We believe the company should continue to deliver strong
earnings growth in F13e: US$ revenue growth should be in
line with that of the industry, as per NASSCOM forecasts, and
EBIT margin should improve strongly. We forecast strong
revenue and EBIT growth of 26% and 48% yoy in F13e.
However, due to increase in effective tax rates, earnings
growth is likely to be ~20% yoy in our view.
Expect US$ revenue growth of 14% yoy in F13e… We
expect PE services (33% of revenues) to grow at mid-single
digits yoy in F13e (vs. flat yoy in F12) and expect IT services
(67% of revenues) to grow at high teens in F13e due to lack of
large deals ramp-ups similar to F12 and the current uncertain
macro environment. Overall, revenue growth may not be
significantly ahead of industry in F13e and have lowered our
US$ revenue growth forecasts for F13e-14e by ~1%. We
forecast US$ revenue CAGR of 16% over F12-14e.
…with continued improvement in margins… MindTree
improved its operating margins significantly in F12 – +460bps
yoy, to 11.7%. Even so, we think its exit margins of 15.5% and
recent rupee depreciation should help it absorb the impact of
wage hikes and improve margins further in F13e. We forecast
EBIT margins to improve in F13e to 13.7% (+200bps yoy),
leading to EBIT growth of 48% yoy. The increase in projected
EBIT margins is partly driven by our revised currency
assumptions.
…driving 20% yoy earnings growth for MindTree in F13:
Strong EBIT growth would be partially offset by FX losses on
hedges and higher tax rates, leading to earnings growth of 20%
yoy in F13e. Overall, we forecast earnings CAGR of 15% over
F12-14e.
What’s changed?
We have lowered our US$ revenue forecasts for F13e-14e by
~1%, reflecting management commentary that outlook for
product engineering services have weakened over last few
months.
MindTree has moved up its EBIT margins from 6.8% in 1Q to
15.5% in 4Q. We believe MindTree would be able to improve its
operating margins in F13e to ~13.7%. (vs our earlier forecast of
11.5%).
We have revised our currency assumptions by 5% (from
Rs50/US$ earlier to Rs52.5/US$ for F13e).
Overall, the above changes have resulted in our earnings
forecasts for F13e and F14e moving up by 23% and 21%,
respectively.
Valuation Methodology
We have raised our price target to Rs765 per share: We
factor in the following:
• Our earnings estimate increases (plus higher assumptions
in our bear case)
• A lower probability for our bear case scenario, and
accordingly higher weightings for our bull and base cases
Our price target for the stock is derived as the weighted
average probability of our risk-reward scenarios. [PT Rs765 =
Rs880*35% +Rs730*55% +Rs550*10%]. We derive our
scenario values using discounted cash flow (DCF)
methodology. Our CoE assumption remains 11.4%.
Base Case
Weighting to 55% from 50%: We have adjusted our
probability weighting for our base case to reflect higher visibility
and certainty for our revised earnings forecasts.
Value to Rs730 per share (up 20% from Rs610): This
increase is in line with the revisions in our earnings estimates
over F13e-14e. In our base case, we believe MindTree should
deliver US$ revenue growth in line with NASSCOM’s forecast
of 11-14% yoy in F13e, with improved margins helped by
currency.
Over the longer term (F2012-21e), we expect revenue and
EBIT CAGRs of 12.8% and 13.7% respectively (previously
13.2% and 16.7%, respectively over F11-21e). Our revised
assumptions reflect the higher base of F2012 and hence they
appear lower than our previous forecasts over F2011-21e.
Our base-case value implies a P/E of 11x F2013e base case
EPS, which is in-line with its long-term average of 12x one year
forward earnings.
Bull Case
Weighting to 35% from 25%: We have raised our bull case
because MindTree continues to deliver earnings ahead of
expectations and stronger than expected revenue growth could
lead to further upside in our margin assumptions.
Value to Rs880 per share (up 22% from Rs720): We have
raised our bull case scenario value in part because MindTree
continued to deliver earnings ahead of expectations through
F12. We believe that in our bull case, MindTree would continue
to grow significantly ahead of industry-average rates.
We forecast revenue and EBIT CAGRs of 17.7% and 18.5%
respectively over F12-21e (previously 18% and 22.5%
respectively, over F2011-21E). Our revised assumptions are
on the higher base of F2012 and hence appear lower than our
previous forecasts over F2011-21e.
Our bull case implies a P/E of 13x F2012e bull case EPS. This
is closer to the higher end of the P/E band (6x-18x) in which the
stock has traded over the last 12 months.
Bear Case
Weighting to 10% from 25%: The lower probability we attach
to our bear case scenario now reflects lower downside risks to
our estimates, since the rupee has depreciated significantly
over the last 1-2 months, which benefits MindTree’s margins.
Further, in the event of any improvement in business
environment, MindTree could deliver stronger US$ revenue
growth than a low benchmark (of ~8-10% US$ revenue growth)
in our bear case scenario.
Value to Rs550 per share (up 72% from Rs320): We believe
strong earnings in F12 have set the base for performance in
F13e. MindTree’s 4Q revenue run rate would imply growth of
~4% yoy in F13e. We believe that even in our bear-case
scenario, MindTree should be able to generate low-teens
earnings growth in rupee terms in F13e, helped by currency
depreciation.
Our long-term forecasts for revenue and EBIT CAGR are 10%
and 8.5%, respectively, over F2012-21e (previously 6.9% and
5.5% respectively over F11-20e).
Our bear case implies a P/E of 9x F2013e bear case EPS. This
is closer to the lower end of the P/E band (6x-18x) in which the
stock has traded over last 12 months.
Downside risks to our price target
1) Despite budget closures and flat to higher budgets yoy,
MindTree’s revenue growth could falter because of a tough
macro environment and continued delays in decision making.
2) Slow recovery in PE services revenues could drag on
revenue growth. 3) Rupee appreciation and higher costs drag
on margins.
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