Mindtree Ltd’s shares have done wonderfully over the last year as revenue accelerated and the management forecast a better FY19, tracking strong orders. In line with the management commentary, the company began the current fiscal year on a strong note with dollar revenues growing about 20% in Q1 from a year ago.
What’s more, revenue visibility remains healthy with the company signing total contracts worth $306 million (up 2.7% from Q4 FY18). The strong revenue growth should justify investors’ faith in the stock. But at 21 times FY20 earnings estimate, Mindtree is now being valued almost on a par with Tata Consultancy Services Ltd (TCS).
True, the company is indeed delivering strong revenue growth. But TCS’s revenue is far more diversified (making it less susceptible to client-specific issues) and profitable.
Also, client concentration remains high at Mindtree. The top client generated almost one-fifth or 19.4% of the company’s revenues last quarter. As Emkay Research points out, such a high contribution has competition and pricing risks.
The company is focusing on diversifying its revenue base. But much of the success will depend on business traction at the clients’ end. An analyst at a domestic broking firm says incremental revenue contribution from the non-top 10 clients has been decent last quarter. With revenue growth remaining fairly strong, one should watch out for profitability, which is the key to earnings upgrades now, says the analyst.
The June quarter has been a dampener on this. The margin drop has been more than expected. According to the company’s management, an endowment donation to a university added to the wage hike bill in the June quarter, impacting profitability. The management expects profitability to improve for the full year (FY19).
Even so, the near-term outlook on profitability improvement remains hazy with the impact of new employee additions and rise in wage bill expected to be felt in the second quarter too.
There is also a concern on the company’s plan to raise corporate social responsibility spends. Some fear donations (some dubbed as investments) on this front can weigh on quarterly profitability numbers.
So even as Mindtree delivers on the revenue growth front, the lack of clarity on the trajectory of profitability improvement can be a limiting factor to earnings upgrades, potentially capping stock gains in the near term.
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