Graphic: Paras Jain/Mint
Graphic: Paras Jain/Mint

Mindtree investors cheer stability signs; execution, earnings accretion are key

  • The new management at Mindtree is filling the gaps in senior roles with a mix of external and internal hires
  • The company is setting up a new team under a senior resource hired from a tier-I IT firm to pursue large deals

Shares of Mindtree Ltd gained 6.8% this week as its management’s interactions with analysts and investors revealed signs of stability.

The company managed to retain the client base though a slowdown in decision-making is visible at certain customers, analysts at Kotak Institutional Equities said in a note after a meeting with the management.

Outlook for the top client remains strong. The new management at Mindtree is filling the gaps in senior roles with a mix of external and internal hires. Further, the management indicated focus on large deals and expansion of service offerings.

The company is setting up a new team under a senior resource hired from a tier-I IT firm to pursue large deals. It plans to drive the deal sizes through more service offerings and end-to-end solutions.

The management sees substantial scope for growth tapping the current clientele itself. “Company remains confident in closing a few deals with total contract value of $50-80 million over next few quarters," an analyst at another broking firm said in a note, on condition of anonymity.

The commentary is predictably cheering investors. Unlike other IT companies, Mindtree is heavily dependent on its top clients.

Its top client generates more than a fifth of revenue. Revenues from the top 10 clients constitute 43% of the total. In this backdrop, the new management’s confidence about client mining and deal activity is comforting. With sizes of the digital deals increasing, the strategy to step up focus on large deals seems appropriate as well.

But as displayed at larger peers, achieving momentum in business is one thing and earnings conversion is another. Even as deal wins picked up, profitability lagged at a couple of large IT firms in recent quarters.

The case is no different at Mindtree, which has seen its operating profit margins drop to 10% in the first quarter of FY20. Profit margins improved in the second quarter. However, the recovery is slow and they remain below the year-ago levels.

As a consequence, even as the company’s dollar revenue grew 10% from a year ago, net profit dropped 34% last quarter.

Apart from optimizing traditional levers such as utilization levels, onshore-offshore mix and curtailment of investments, Mindtree aims to improve the business mix by ramping up the managed services business.

However, execution is key. Managed services has not been a particular strength of Mindtree traditionally, warn analysts at Kotak.

Also, drastic rationalization of costs can further worsen attrition. Progress on this will be important. “Achieving margin swing is key for the stock to deliver strong absolute upsides," added the second analyst cited above.

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