Monday, April 6, 2009

CMC - Buy

Investments with a two-year horizon can be considered in the shares of CMC, in the light of the stock’s reasonable valuations. The company is an integrated IT systems player and has managed a fruitful margin expansion drive through a change of its business mix. A roster of domestic and international clients, especially government clientele where large deals continue to be won, and improving prospects for its education and training divisions promise broad-based growth for CMC. The synergies that accrue from its association with TCS (of which it is a subsidiary) have also resulted in domestic as well as overseas deal wins for CMC. At Rs 352, the share trades at five-six times its likely 2009-10 earnings. This is at a slight premium to HCL Infosystems. But CMC enjoys a much higher EBITDA margin of close to 15 per cent and a net profit margin of over 11 per cent, which justifies this premium. The stock has fallen over 55 per cent in the past year, largely on concerns about a global slowdown in hardware demand and currency fluctuations impacting profitability. But the decline in revenues in the last couple of quarters appears attributable to a conscious decision to reduce focus on its low-margin hardware-equipment, sales-intensive customer services business. From 60 per cent of overall revenues, this proportion has, over the last three quarters, declined to less than 40 per cent. The company is looking at tapping deals that involve a higher service component which it hopes to deliver through its high-margin system-integration offering. CMC derives 60 per cent of its revenues from India and the rest mainly from US . This mix in a way nullifies the effect of dollar fluctuation against the rupee and acts as a natural hedge, lowering the forex risks to the company’s earnings. Changing business mix Equipment sales will still remain a key offering for CMC, but pursuing a strategy wherein equipment sales is followed up with a meaty services component may help improve margins over the long term. But it may be a few years’ time before equipment sales decline to a small part of the revenue and CMC becomes a complete IT solutions company. The change in focus has meant that its ITES (IT Enabled Services) division which manages IT applications and is also involved in digitisation services has grown 20 per cent this fiscal. Also, system integration, that contributes 45 per cent of overall revenues, is now the main contributor to overall revenues. This is significant as systems integration is a high margin service (30 per cent PBIT margins). This change in business alignment means that the company is now well-positioned to win deals overseas, especially from the US, where requirements go beyond mere equipment sales and implementation. The company has won two deals with local governments in two counties in the US for providing various citizen services. The synergy from TCS is also quite pronounced as CMC is now able to participate and benefit from large infrastructure management deals that TCS wins and also expand margins by services delivery of its own. TCS’ deal with the Ministry of External Affairs for passport issuance to citizens of India is one such example. The deal size is around Rs 1,000 crore, spread over six years. This deal follows an earlier one that TCS had won with the Department of Company Affairs in 2006, which was worth around Rs 345 crore. CMC was also a beneficiary of the deal. The present deal would entail TCS digitising and enabling online filing of applications for passports. In most of these areas it is CMC that is expected to play a key role in the service delivery. This apart, the company has been expanding client relationships in areas such as defence, e-governance, ports and transportation, all key drivers of domestic IT spend. CMC’s education and training division has grown 20 per cent in the December 2008 quarter over December 2007. Apart from vocational and IT (Hardware, networking and software) training, the company also trains users at client’s location. For example, CMC would handle the IT infrastructure and management and provide education and training services to the client company’s personnel at these outlets. This means additional revenues for CMC. For the nine months of FY09, the company has seen a decline of 16 per cent in its revenues, but net profits have grown by 10 per cent. In terms of risks, competition from entrenched players such as HCL Infosystems and Wipro Infotech may create pricing pressure for CMC. source : businessline