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Krishnan Thiagarajan

Mr Ashank Desai, Chairman

INVESTORS can consider retaining their exposure in the Mastek stock. At the current price levels of Rs 359, the stock trades at a price-earnings multiple (PEM) of 9.9 times its annualised 2004-05 earnings.

The `Hold' recommendation is based on the strong offshoring momentum from application development projects in Europe, especially the UK; the good order-book position, and the stable pricing environment.

Mr Sudhakar Ram, Chief Executive Officer

Causes for concern include the high client concentration levels, the company's ability to scale up performance in the US market, and the sluggish performance of the joint venture with Deloitte Consulting in the latest quarter.

Financial highlights

In the latest quarter ended December 31, 2004, the Mastek Group revenues registered a sequential rise of 7.3 per cent to Rs 140.1 crore. The post-tax earnings (after minority interest) grew 4.9 per cent to Rs 12.8 crore.

On a sequential basis, the operating profit margin fell marginally to 17.3 per cent, but up by 4 percentage points over the corresponding previous period.

The contribution of the UK operations has been the key driver of the profit margins in the latest quarter. Apart from growth in revenues by 22 per cent from the UK segment, the profit before interest and tax (PBIT) margin also improved by 4 percentage points sequentially to 23 per cent.

In contrast, the US operations and the joint venture with Deloitte Consulting have seen a decline in revenues and PBIT.

For the January-March quarter, Mastek expects the group income to be in the Rs 145-150-crore range — 3.5-7 per cent over the previous quarter.

The post-tax earnings will be in the range of Rs 13.25-14.25 crore — a 3.5-11 per cent growth over the previous quarter.

Variables at play

The second half of 2004-05 may be dictated by the following positive variables:

The application development focus: As the information technology spending, particularly in the UK and the US, is staging a recovery, Mastek, with its strong application development focus, may be in a position to capitalise on this trend. Over 65 per cent of the revenues in the latest quarter came from application development, with the balance coming from maintenance.

This positive trend, along with stable billing rates, especially for development clients, can work to Mastek's advantage. The company has executed complex projects in the UK, such as the London Congestion Charge, and is now working on the National Health Service Spine project.

Vertical focus: Nearly 85 per cent of Mastek's revenues accrues from two key verticals — financial services (including insurance) and government. Of this, over 50 per cent is derived from financial services, the largest spender on information technology.

While the competitive pressure is the highest in this space, Mastek's strong focus may pay-off in this bullish environment.

The total order backlog for the latest October-December quarter stands at Rs 280 crore. At the same time, Mastek remains exposed to some key risks and challenges:

Client concentration risk: The contribution of the top five clients rose to 61 per cent of revenues in the October-December 2004 quarter, up from 42 per cent in the corresponding previous period.

In the past, this has exposed them to the client replacement risk. On completion of the London Congestion Charge project in June 2003, Mastek was unable to replace this client with others adding up to this size.

Widening the geographic base: While Mastek has established itself in the UK region, particularly in the government verticals, its success in the American market remains untested.

From the segmental contribution of the US geography, it is obvious that Mastek still has a long way to go to get its act together.

The contribution of the US geography is also significant as it has the potential to generate annuity revenue streams, bringing greater predictability to Mastek's overall revenues.

Performance of the Deloitte JV: In the latest quarter after review, Mastek has renewed its joint venture with Deloitte Consulting.

But the performance of this joint venture has slipped in the latest quarter compared to last year. Unless this picks up, it can prove to be a drag on Mastek's overall financial performance.

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