Jolting numbers

BS Compass

Mastek had a lot of explaining to do at its analysts meet held on Tuesday. To start with, its June quarter (fourth quarter for the company) results were a disaster, as revenues fell 10 per cent sequentially and profits dwindled by 82 per cent.

Besides, the company gave a rather unpleasant surprise, when it said that its earnings in FY04 could drop 31 per cent from the FY03 level of Rs 50.5 crore. This, despite the fact that the company expects revenues to grow 21 per cent in FY04.

This is broadly how Ashank Desai, chairman and managing director, explains the disconnect between revenue and earnings growth, "Within four to six quarters of the US economy reviving, we expect a major surge in offshore outsourcing to India. It is essential for Mastek to scale to critical mass to take advantage of this tremendous opportunity. We have, therefore, consciously decided not to compromise on the sales and marketing effort that has worked quite well. On the other hand, gross margins will be under substantial pressure due to customer expectations of aggressive pricing. This would lead to an adverse impact on the bottom line."

Essentially, Mastek is focusing on size and scale over the long-term, in an attempt to figure among the top IT companies in the country.

But this has come at the cost of near-term profitability, which has ironically resulted in a huge drop in its market cap ranking.

When Mastek had announced its March quarter results, it was ranked ninth among IT companies in terms of market cap, but after the June quarter results it's fallen to the nineteenth spot.

The company is factoring in a 6-7 per cent decline in average billing rates in its FY04 guidance, which is expected to lead to a 600 basis points decline in gross margins.

It's mainly this factor that explains the expected fall in earnings in FY04. In fact, even net profit margin is estimated to fall around 600 basis points to 7.6 per cent.

The company has further said that the first half of FY04 will account for only 40 per cent of the year's revenues and 20 per cent of profits.

What this implies is that the net margin in the first half period will continue to be almost as bad as it was in the June quarter.

The second half period is expected to be better, but the estimated net margin of 10 per cent would still be lower than the FY03 level of 13.5 per cent.

In summary, it'll be a while before Mastek's results can return to normalcy, which could result in a further slip in its market cap ranking.

EID Parry

EID Parry's intention to exit its fertiliser and pesticides business is a good one. It will be transferring the division to its subsidiary Coromandel Fertilisers, and there will be several gains from the transfer.

First, EID Parry's fertiliser division manufactures phosphatic fertilisers and with the recent acquisition of the government's 25 per cent stake in Godavari Fertilisers, the Murugappa group's fertiliser business will now be vested in one company.

The transfer will ensure that the vagaries of the fertiliser industry remain restricted to the performance of one company.

The fertiliser business is highly working capital intensive and EID Parry will be now be able to utilise its funds better.

Further, with the entire fertiliser business in one company, Coromandel will be able to take advantage of economies of scale.

Secondly, of its total debt of Rs 334 crore in FY03, around Rs 110 crore will be transferred to Coromandel, which would result in considerable savings on interest outgo.

Thirdly, the transfer of the fertiliser business will mean a considerable loss of revenues since fertilisers contributed 53 per cent to revenues in FY03.

However, the loss of revenues will be beneficial since the fertiliser business had PBIT margins (profit before interest and tax-to-sales ratio) of 2.6 per cent compared to 4.5 per cent in the sugar business (34 per cent of revenues).

Therefore, the loss of revenues will improve overall margins. Although the bottomline will still be impacted, the loss will be lower since there will be a benefit due to the higher margins and lower interest outgo.

In fact, the higher margins and the lower debt could result in a likely improvement in discounting over the next few years from current levels of around 8 times.

With contributions from Mobis Philipose and Sameer Ranade