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India Equity Research Reports, IPO and Stock News
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Tough road ahead
Downgrade to REDUCE, significant risk to Street EPS
Operational improvements may not offset macro hurdles
Price losses could put margins under further pressure
Heightened risk aversion likely for mid and small caps
Downgrade to REDUCE
We downgrade MindTree to REDUCE
(from Hold) and the Indian IT services
sector outlook to DETERIORATING. Even
though the company has high near-term
revenue visibility, we believe the
environment could worsen by late 2011
given our economists forecast of a 50%
probability of a US recession over the
next six months. We also believe the
pricing could be hurt, while lower visibility
could reduce fresh graduate hiring – both
of which could adversely impact
MindTree’s margin improvement
programme. In recent investor meetings that we hosted, the CEO was
not concerned about the deteriorating macro picture then, but has since
said that the company was assessing the situation given the extreme
nature of recent events.
Back-to-basics programme only just started delivering
Over the past few months, MindTree has emerged strongly by focussing
on its key clients and exiting smaller sub-verticals. This comes after
about a year of strategic mis-steps (venturing into handset design and
later abandoning it, ex-Chairman resigning). The company reported a
solid 1QFY12 and management sounded upbeat on the business and
remained confident of beating the FY12 industry revenue growth (16-
18%, as per Nasscom). MindTree’s new revenue is coming from
European clients and three recent large infrastructure management deals
(together USD100m in size over five years) that are ramping up.
However, demand weakness could hurt progress
During the previous downturn in 2008-09, MindTree reported successive
quarters of 8-9% q-q USD revenue declines on a combination of pricing
and volume cuts. We fear that a repeat of such a situation could hurt the
company’s already low margins (~11% EBITDA in 1Q) even more and
cause considerable damage to valuations. We cut our FY13-14 revenue
estimates by 10-11% and our EPS estimates by 17-20%.
Valuation and target price derivation
In 2008-09, FY10 P/E multiples contracted 30-50% for large-cap Indian
IT stocks, while those of some mid-cap companies fell more to
fundamentally unjustifiable levels. Given likely investor risk aversion
ahead, we believe there is a strong-enough reason to avoid smaller
Indian IT names. To capture this extra risk, we increase the beta in our
DCF model to 1.1, from 1.3. As a result of this and our estimate cuts, our
TP falls to INR270 (from INR400), which implies an FY13E P/E of 8.3x.
Risks: unexpected USD/INR weakness, less-than-expected deterioration
of the macro environment.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Tough road ahead
Downgrade to REDUCE, significant risk to Street EPS
Operational improvements may not offset macro hurdles
Price losses could put margins under further pressure
Heightened risk aversion likely for mid and small caps
Downgrade to REDUCE
We downgrade MindTree to REDUCE
(from Hold) and the Indian IT services
sector outlook to DETERIORATING. Even
though the company has high near-term
revenue visibility, we believe the
environment could worsen by late 2011
given our economists forecast of a 50%
probability of a US recession over the
next six months. We also believe the
pricing could be hurt, while lower visibility
could reduce fresh graduate hiring – both
of which could adversely impact
MindTree’s margin improvement
programme. In recent investor meetings that we hosted, the CEO was
not concerned about the deteriorating macro picture then, but has since
said that the company was assessing the situation given the extreme
nature of recent events.
Back-to-basics programme only just started delivering
Over the past few months, MindTree has emerged strongly by focussing
on its key clients and exiting smaller sub-verticals. This comes after
about a year of strategic mis-steps (venturing into handset design and
later abandoning it, ex-Chairman resigning). The company reported a
solid 1QFY12 and management sounded upbeat on the business and
remained confident of beating the FY12 industry revenue growth (16-
18%, as per Nasscom). MindTree’s new revenue is coming from
European clients and three recent large infrastructure management deals
(together USD100m in size over five years) that are ramping up.
However, demand weakness could hurt progress
During the previous downturn in 2008-09, MindTree reported successive
quarters of 8-9% q-q USD revenue declines on a combination of pricing
and volume cuts. We fear that a repeat of such a situation could hurt the
company’s already low margins (~11% EBITDA in 1Q) even more and
cause considerable damage to valuations. We cut our FY13-14 revenue
estimates by 10-11% and our EPS estimates by 17-20%.
Valuation and target price derivation
In 2008-09, FY10 P/E multiples contracted 30-50% for large-cap Indian
IT stocks, while those of some mid-cap companies fell more to
fundamentally unjustifiable levels. Given likely investor risk aversion
ahead, we believe there is a strong-enough reason to avoid smaller
Indian IT names. To capture this extra risk, we increase the beta in our
DCF model to 1.1, from 1.3. As a result of this and our estimate cuts, our
TP falls to INR270 (from INR400), which implies an FY13E P/E of 8.3x.
Risks: unexpected USD/INR weakness, less-than-expected deterioration
of the macro environment.
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