The Hindu Business Line : Mastek: Buy

Mastek's strong order book position, its progress into the US market and a steady improvement in financials are encouraging. Slowdown in US and high client concentration remain the key risks.

MR SUDHAKAR RAM, CEO, Mastek

Investors can consider exposure in small lots in the Mastek stock with a one/two-year perspective.

At the current market price, the price earnings multiple works out to 14 times its 2005-06 per share earnings.

Given that the stock has been locked in the Rs 335-355 price band for the past month, capital appreciation may be much more sedate vis-à-vis other mid-size software stocks of this genre.

Mastek's strong order book position driven by offshoring momentum, progress into the US market through its insurance solution, and steady improvement in financials are encouraging.

While the revenue and earnings growth, projected at 4.5 per cent and 2.9 per cent respectively for the first quarter of 2006-07, are somewhat muted, the overall momentum on the financial front remains strong.

On the flip side, however, as a chunk of Mastek's revenue flows from project development, any slowdown in discretionary IT spends could have an adverse impact on its financials.

A slower-than-expected penetration and scale-up in the US geography, deterioration in the performance of the joint venture with Deloitte, and high client concentration remain key risks from a medium term perspective.

Financial snapshot

For the year ended June 30, Mastek clocked a revenue growth of 21.4 per cent to Rs 688.3 crore and a post-tax earnings growth (after minority interest) of 29.3 per cent to Rs 69.1 crore over the previous year.

The operating profit margins (OPM) perked up 1.6 percentage points to 17.2 per cent. The company has indicated that its revenue growth in 2006-07 will be higher than in 2005-06, with 1-1.5 percentage point improvement in the OPM derived through selling, general and administrative (SG&A) leverage.

For the fourth quarter ended June 30, the company recorded a 6.6 per cent sequential growth in revenue to Rs 189 crore along with an impressive 19 per cent rise in post-tax earnings to Rs 20.6 crore.

Key operating metrics

For the year and latest quarter ended June 30, revenue growth and profit before interest and tax margins from the European markets continue to be robust. The US market is witnessing traction on account of the increased acceptance of its insurance solution, Elixir. The revenues from the insurance vertical accounted for 25 per cent of the total in the latest quarter.

Currently, eight out of the top 20 global insurance companies are clients of Mastek. Besides this, a sharp rise in the proportion of revenues from fixed price projects is encouraging. Though this exposes the company to greater execution risks, it is likely to expand its margin leverage.

The company's order book, executable over the next 12 months, stands at Rs 382 crore. Though the order book has remained flat on a sequential basis, considering the sharp 22 per cent rise in the order pipeline in the previous quarter, this is not an immediate cause for concern.

This flattish trend is also a reflection of the long sales cycle and stiff competition in winning large development deals in the financial services and government space.

Key risk

One of the key risks continues to be the company's high client concentration levels. In the latest quarter, the top five and top ten clients accounted for 71 per cent and 86 per cent respectively of revenues. The top five clients also powered the sequential growth in revenues.

The number of active clients of Mastek has come down to 40 from 51 over the past year. However, the number of Fortune 1000 clients has remained constant at 19.

The company has clearly stated that it plans to stick with its strategy of working with partners such as Capita; its recent tie-up with Euriware, a French IT services company and a wholly owned subsidiary of energy major, Areva, is an extension of this strategy. Through this exclusive partnership, the company is expecting to clock revenues of 35 million euro over a three-year period.

This will start contributing to revenues from the first quarter of 2006-07.

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