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Buy Mindtree, target Rs 1,050: Reliance Securities

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The Economic Times
15th March, 2019 13:24 IST

Reliance Securities has a buy call on Mindtree with a target price of Rs 1,050.

The current market price of Mindtree is Rs 947.80.

Time period given by the brokerage is one year when Mindtree price can reach the defined target.

The brokerage recently interacted with the management of Mindtree for a business update.

Following are the key takeaways of their interaction:

Deal pipeline strong; client commitment lower: Mindtree’s deal pipeline is at an all-time high in value terms. Clients are investing in digital transformation almost across-the-board on one hand while looking for cost optimisation on traditional services through automation on the other. On account of the volatile global macroeconomic environment, visibility of IT budgets has reduced to 3-4 quarters, as against 3-4 years earlier.

Talent shortage biggest challenge; BOT use to drive re-skilling: A challenge is re-skilling employees on new technologies. Mindtree is focusing on automation through BOTs, leading to savings on time spent by employees on repetitive tasks and refocusing efforts on re-skilling. Mindtree had 518 BOTs in operation as of 3QFY19-end. Cost savings are passed on to the customer. Cost of talent is on the rise led by the shortage of digitally trained staff. This is leading to a rise in the use of subcontractors. The cost of subcontracting rose by >62 per cent YoY in 3QFY19 (up 151bps YoY as a percentage of revenue); figures for 9MFY19 are 59 per cent YoY and 395bps YoY.

New CFO focusing on operational efficiency; enough levers in place: Mindtree’s recently-appointed new CFO, Pradip Menon is focusing on several levers to manage margins including lowering subcontracting cost, raising utilisation close to 80 per cent ex-trainees, employee pyramid and higher offshore component. Thus far in 9MFY19, EBITDA margin has risen by 250bps YoY, with EBITDA in absolute terms up >55 per cent YoY. The margin is likely to come in at 15.3 per cent in FY19E and we believe, with healthy revenue growth led by digital, Mindtree’s margins can range between 15.5-16 per cent over the next 2 years.

Retail, travel outlook healthy; BFS to remain subdued: From a vertical perspective, Retail, Travel and Hi-Tech & Media are witnessing substantial digital transformation investments by client organisations. Insurance is also seeing digital investments, with Mindtree one of the main partners for Duck Creek (P&C insurance products) after Accenture’s exit. On the other hand, BFS vertical remains subdued, as the company has been unable to meaningfully participate in digital investments, being a late entrant to this domain.

Faster sequential revenue growth in 4Q; margin to remain flat: Mindtree’s 4QFY19E growth outlook remains the same as given post 3QFY19 earnings conference call, with revenue to grow at a better pace than 3Q, while margin is likely to remain flattish owing to business-related investments to be made.

Outlook & valuation: Mindtree’s growth momentum has been robust in FY19 so far, led by Retail, Travel and Hi-Tech verticals. TCV wins grew by 16.8 per cent YoY in 9MFY19, reflecting good underlying business growth and providing good revenue visibility. We expect Mindtree’s USD revenue to clock 15.6 per cent CAGR over FY18-FY20E, one of the highest in the industry. We maintain our BUY recommendation on the stock with a Target Price of Rs 1,050. A key overhang is the stake sale of VG Siddhartha, the single-largest shareholder in Mindtree, which could lead to possible management changes as the buyer will then acquire the majority stake.

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