Further upside in Mindtree may be capped

Supply side pressures could hit efforts to maintain margins above 20%

Mid-cap information technology major Mindtree was the biggest gainer in the IT space over the last month fetching investors 35 per cent returns. This was over four times the returns of the Nifty IT index over this period.

Revenue visibility on the back of record deal pipeline, recovery in travel, transportation and hospitality vertical, strong margin guidance despite cost pressures and an IT mid-cap rally have acted as tailwinds for the stock.

After the highest organic growth among peers of 7.7 per cent on a sequential basis in the first quarter of financial year 2021-22 (Q1FY22), the company is expected to maintain a double-digit growth for the full year, outperforming peers.

The firm’s deal intake remains high with record value of $504 million in Q1 as compared to the deal wins in the range of $303 million to $393 million over the last five quarters. Growth in net additions (hiring) for the company over the last 12 months at 24 per cent was the highest in the large and mid-cap space.

What could help the company is a diversified presence across verticals and contribution from the European market. Analysts at Prabhudas Lilladher Research point out that Mindtree’s investments to expand its presence in Europe over the last several quarters are yielding results with record high sequential growth in Continental Europe of 13.1 per cent in dollar terms in Q1.

Record deals and strong revenue growth are positive, but some analysts believe that there could be some headwinds for the stock given high client concentration (top client accounts for 27 per cent of revenues), ability to meet margin targets, and supply side pressures.

The company has a target of 20 per cent plus operating profit margin for FY22, an analyst at a domestic brokerage believes it will be tough to achieve that number. This is due to high attrition levels, wage hikes that could hit margins as was the case with L&T Infotech (250 basis points impact) and higher travel costs.

The other factor that may limit upsides are valuations. The stock is trading at 42 times its FY23 earnings estimates as compared to tier-1 valuations of 21-35 times, while its mid-cap peers are available at 36-42 times range. Investors should await a sharp correction in the most expensive IT stock in the large and mid-cap space before considering investing for the long term.