CMC: Buy

The US remains a stable and growing market for outsourcing services over the past couple of years. This trend has benefited many mid-tier IT companies which have managed to expand their footprint in the North American region at a healthy pace. CMC is one such company that expanded both in the US and India.

A healthy blend of offerings in favour of system integration solutions, which sustained momentum in winning contracts, and an increasing tilt towards international (largely the US) revenues are key positives for the company. The association with its parent company, TCS, has also helped CMC tap into newer segments and expand its client base.

In the first nine months of 2013-14, CMC’s revenues grew 14.6 per cent to about ₹1,608 crore over the same period in the previous fiscal, while its net profit rose 13.1 per cent to ₹191 crore. An operating margin of close to 17 per cent places it among the best in its category.

Investors with a two-year horizon can consider buying the shares of CMC in the light of the growth drivers mentioned above. At ₹1,430, the stock trades at 12 times its likely per share earnings for 2014-15. This is at par with most mid-tier IT companies and is lower than its historic multiples.

Over the past four years, with its service offerings expanding, CMC has made a significant transition from being a hardware-intensive, low-margin player to a more services-centric company.

The company’s systems integration division with a strong software component (over 63 per cent of revenues), application development and maintenance, and ‘embedded’ systems are typically high-margin businesses. This segment’s growth rate matches or is faster than the overall revenue rate of the company.

CMC’s more hardware-intensive customer services unit (18 per cent of revenues) too continues to grow, though at a slower pace, given that the company takes up such contracts only if there is a significant software component to be offered subsequently.

Its third major division, IT-enabled (BPO/KPO) services, (13 per cent of revenues), also continues to show traction. This blend of offerings gives CMC a better chance of winning deals that are non-discretionary in nature.

Also, the company has expanded its client base significantly over the past few years. In 2013-14, it has added 46 clients across geographies, including from India.

The combination of a larger client base and a dispersed geographical presence offer good visibility on future revenue flows and growth prospects.

International revenues (largely from the US) now account for over 67 per cent of the company’s overall revenues, up from 55 per cent levels a year ago. Global operations that provide better margins and are more complex in nature help CMC climb up the services value-chain.

The association with TCS has helped CMC considerably in terms of expanding its footprint in the US and in Europe as well.

In India, the Government, which is increasing its spends on areas such as rural connectivity and e-governance, is a key market for CMC.

Clients include entities such as Indian Railways, Passport Seva and the Election Commission where heavy volume of data is likely to provide sustainable revenues for the company. These apart, the UIDAI (Aadhar project) and several state transport companies that are looking at implementing global positioning systems (GPS) solutions are also CMC’s customers.

India provides about a third of the company’s revenues. Despite deals having significant hardware component, solutions such as GPS and UIDAI would provide steady annuity revenues for the company over the long term.

Private sector clients include entities as diverse as the BSE, Godrej, HUL, ONGC, Pepsico and Godrej. A recent report by research firm IDC forecasts the domestic IT services market to have grown at 8.3 per cent year-on-year in CY2013 to reach $7.97 billion. This expansion in spending has been despite the domestic economic slowdown. IT spends can be expected to grow faster when the economy picks up pace.

Competition in the system integration space from players such as Wipro Infotech and HCL Infosystems could mean pricing pressure for CMC. Hiring more local staff in the US in case of project demands could increase wage costs and affect margins.

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