All’s well at Mindtree, except for high client concentration risk
All of Mindtree’s growth came from its top five clients, and over three-fifths of incremental revenues was on account of just one client
If buzzwords such as digital services, artificial intelligence and bots were enough to excite investors, Mindtree Ltd’s shares should be on fire after its September quarter results. Digital services rose to 48.1% of revenues last quarter, up from 42.6% a year ago. They have accounted for three-fourths of incremental revenues in the first six months of this fiscal year, giving credence to the view that Mindtree has positioned itself well in segments that are growing at faster rates than the overall industry.
What’s more, the company said that it used 484 bots last quarter, up 45% from just two quarters ago. Bots are software that act autonomously, and perform tasks that would otherwise have been done by humans.
In the process, Mindtree’s revenues have grown by 20% in dollar terms year-on-year, far higher than the rate at which the industry is growing.
What’s more, margins have rebounded compared to last year’s low base. Put together with the depreciation in the rupee, earnings have grown at 60% in the first half of the year in rupee terms. Mindtree doesn’t hedge its currency exposure aggressively; thanks to that, most of the gains from the weaker rupee have flown into its profits.
While all this is well and good, the company’s results last quarter again highlighted risks related to client concentration. All of the growth came from its top five clients, and over three-fifths of incremental revenues was on account of just one client. This column has pointed out to the risk of high dependence on one client, which now accounts for one-fifth of total revenues. The problem with high client concentration is that it makes a company susceptible to pricing cuts, as well as large fluctuations in volumes.
Besides, the fact that the other clients didn’t deliver is also a concern. Analysts at Kotak Institutional Equities, for instance, had forecast that revenues from the top client will remain flat given the June quarter’s high base, while other clients will grow by 4%, sequentially.
However, the contribution from the top client continued to race ahead, and revenues from other clients grew less than 1%.
Not too long ago, in 2016-17, Mindtree had issued profit warnings owing to “project cancellations and slower ramp-ups in a few large clients”, among other things. While investors may be tempted to ignore this risk, given the high earnings growth rates currently, it would be prudent to exercise some caution while valuing the company’s shares. At current levels, they trade at 23.5 times trailing 12-month earnings
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