Recovery in Satyam shares little to do with results

Recovery in Satyam shares little to do with results

Shares of Mahindra Satyam underperformed the National Stock Exchange’s CNX IT index by as much as 50% between January 2010 and Friday. In other words, expectations from the company weren’t all that high. So when it reported an 11% sequential growth in earnings before interest, tax, depreciation and amortization (Ebitda) last quarter, a sharp rerating of its shares followed. The company’s shares rose by as much as 12% after it announced better-than-expected results for the quarter ended December.

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But the sharp jump in its shares shouldn’t be mistaken as a sign that the company’s fortunes have changed. True, the results were better than expected…, but only just. Revenue grew by 3% sequentially and operating margin rose by 50 basis points. Neither of these improvements is exceptional. It’s just that since Satyam operates at extremely low margins of around 6%, a 50 basis points improvement in margin leads to a sharp jump in absolute profit. This is visible in a more pronounced manner at the Ebit level, where profit rose by 43% sequentially on the back of a 96 basis points improvement in margin. Profitability improved thanks to a drop in employee costs as a percentage of sales, which offset an increase in other overheads.

It’s important to note here that none of this would lead to a meaningful tweaking of analysts’ earnings estimates. Most brokerage houses are already factoring in a significant improvement in margins to healthy double-digit levels by fiscal year 2012-13. While the 50 basis points improvement in margins last quarter is good, there’s still a long way to go before the company reaches estimated profitability levels.

The sharp jump in the company’s shares is primarily because it had undperformed its peers by a large margin in the run-up to the results. Since the beginning of the results season, Satyam shares have fallen by 16%, almost double the rate at which the CNX IT index fell. It must also be noted here that a number of mid-cap IT stocks rose sharply on Monday, with the recovery in the markets gathering steam. The rise in Satyam’s shares, therefore, isn’t entirely linked to its results.

Graphic by Naveen Kumar Saini/Mint