Higher valuations overhang for Mindtree

Delays in implementation of some projects in retail & consumer packaged goods contribute to fall in stock

Mindtree shares have fallen 14 per cent in two trading sessions, of which 11.6 per cent decline was on Wednesday, vis-a-vis a flattish S&P BSE Sensex as the company trimmed its revenue growth (organic) as well as margin expectations for the March 2016 quarter. Delays in implementation of some projects in the retail and consumer packaged goods (one-fifth of revenues) and banking, financial services and insurance (one-fourth of revenues) verticals are the key reason behind this warning, which was issued late evening on Monday. After this warning, brokerages have trimmed their FY17/FY18 revenue estimates by two or three per cent and earnings estimates by five or six per cent as analysts are concerned on the weakness in two of its key verticals. At Wednesday's closing price of Rs 684 a share, the Mindtree stock trades at 18 times FY17 estimated earnings. Given the near-term growth concerns and higher valuations (its historical average one-year forward price-to-earnings ratio is 12 times), expect the stock to remain under pressure.

On Thursday, however, the stock will adjust for the one-for-one bonus issue that Mindtree has announced.

  While management commentary on demand trends across key verticals will be keenly watched from here on, it is still early to assess whether the project delays are one-offs. With increasing digitisation across sectors, deal sizes as well as tenures are shrinking, leading to higher volatility, and that's not the case just with smaller companies but with bigger firms, too.

For the on-going quarter, the company expects sequential dollar revenue growth (organic revenues) to be marginal versus earlier expectations of 2.3 per cent growth witnessed in the December 2015 quarter. The revenue weakness could lead to a sequential contraction in operating margins, said the company. Including acquisitions, while sequential dollar revenue growth will be better than that in the December 2015 quarter on completion of acquisition of Magnet 360, the latter’s lower margins vis-a-vis that of Mindtree will have an impact on overall margins in the quarter.

Positively, despite the weakness in this quarter, the company is confident of beating the Nasscom FY16 revenue growth guidance of 10.3 per cent, thanks to the good show in the first nine months of the financial year. Analysts at Motilal Oswal Securities estimate organic revenues to grow 15 per cent in constant currency terms in FY16. For FY17, too, the company remains confident of beating the Nasscom revenue growth guidance of 10-12 per cent on the back of positive demand trends. While it is not clear if this guidance includes inorganic growth as well, for now, analysts are pegging organic revenue growth of 12.5 per cent for Mindtree in FY17.

Among other triggers, the details about the growth strategy adopted by the new CEO will be key in determining future prospects of the company.

Mindtree has been stepping up focus on digital (36 per cent of revenues) via strategic acquisitions in this space. Mindtree also has a host of margin levers at its disposal such as lower utilisation rate (69 per cent), relatively higher selling, general and administration expenses, among others. However, continued revenue momentum is essential for any margin improvement, say analysts.