>MINDTREE (ICICI SECURITIES)

Green shoots to full bloom

MindTree enjoys strong management bandwidth versus other mid-caps and provides an attractive alternative to Fortune-500/1000 clients besides large vendors. However, the company can witness continued growth volatility given higher project-based revenues. With signs of recovery in global economy, we expect growth beyond FY10 to be healthy for MindTree given expected pick-up in discretionary spend for the industry and resulting margin uptick for MindTree as most of the margin pressure is bottoming out. Despite the stock’s run up recently, we initiate coverage with BUY and Rs725 target price. Our target FY11E P/E is at ~30% discount to Infosys’ target P/E, which we believe is fair considering MindTree’s quality management, better corporate governance and EBITDA & EPS CAGR of 20% and 12% respectively through FY10E-12E.

■ Client mining – Steps in the right direction. Earlier, MindTree underperformed peers on client mining despite a marquee client list. But recently it has addressed these by: i) recruiting lateral account managers from large global IT companies (account manager strength rose to ~10-12 from 2-3 YoY), ii) exiting ~50 client accounts given scale-up issues due to limited scope and iii) multi-service offerings to clients. These investments are likely to yield better results on revenues & margins, when global IT spending is showing signs of recovery even on discretionary/project-based spend, which forms a material part of revenues.

■ Margin-related pressure bottoming out. With likely recovery in IT spending in H2FY10/FY11, we expect MindTree’s EBITDA margin to improve hereon considering: i) utilisation (including trainees) touched a bottom of 61.1% in Q1FY10 from 70% in Q2FY09, ii) billing rate, post Aztecsoft’s consolidation, reduced 5-8% from Q3FY09 levels (Q3FY09, the first quarter to reflect full consolidation of Aztec), iii) Q1FY10 SG&A at 19.5% (similar to pre-IPO levels) versus 16-18% in FY08-09. Besides, we believe, incremental investment in S&M is likely to be lower.

■ Well positioned to outperform with quality management & marquee clients. Given MindTree’s quality management and marquee client list – Volvo, Unilever, LSI Logic, Symantec, United Technologies, Microsoft etc – which acts as a big differentiator versus other mid-cap peers, the company is likely to outperform after FY10. We expect 19% & 20% revenue & EBITDA CAGR in FY10E-12E post 1% & 30% decline in FY10E dollar revenues and rupee EBITDA respectively.

To see full report: MINDTREE