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Strong 3Q led by stellar margin performance

Risk-adjusted valuation remains unattractive

* Mindtree (MTCL) delivered strong revenue growth in 3Q (5.0% QoQ USD), above our estimate of 3.6% QoQ, on a broad-based performance across client buckets and industries (with the exception of BFSI). While deal wins (USD312m) were stable QoQ, they remain c20% below the highs seen some quarters ago.

* More importantly, we were surprised by further expansion in the EBIT margin (+290bp QoQ / +760bp YoY), led by a 430bp QoQ increase in utilization (all-time high) and 70bp increase in offshore mix (six-year high). For 9MFY21, sales (USD) / EBIT / PAT came in at -3%/74%/87%.

* We expect MTCL to continue to benefit from a strong demand environment, especially given the high exposure to cloud (19% of revenues) – USD revenue growth was in the low-to-mid teens. In addition to reporting strong revenue growth, the company should benefit from the massive margin expansion over 2QFY20–3QFY21 (10pp) – the majority of which the management expects to retain despite an increase in investments in sales and new employee additions.

* Hence, despite the near-term drag due to wage hikes in 4QFY21, along with the gradual resumption of travel next year, we raise our FY22 EBITDA margin expectation to 21.1% (19.0% earlier).

* However, we continue to see high exposure to the top client (28.5% of revenues) as a risk – despite modest growth seen over the last two quarters. While MTCL has been trying to diversify its client exposure for a long time, this has only increased (c10pp over FY19–21E), which remains a concern.

* We upgrade our FY22/FY23 EPS estimates by 10%/11% as we factor in 170bp margin expansion, apart from the strong beat during the quarter. The stock is trading at 20x FY23 EPS. It has been one of the best performers in CY20 in the IT sector, with returns of 88% over the past year. We believe the key positives are already captured, and we see limited upside hereafter. Our TP of INR1,765 implies 21x FY23 EPS (15% discount to LTI). Maintain Neutral.

Strong all-round beat

* MTCL’s revenues grew 5.0% QoQ to USD274m, above our estimate of 3.6% QoQ growth.

* The EBIT margin expanded 290bp QoQ to 19.6%, above our expectations of 16.5%. This was largely led by a 430bp increase in utilization and 70bp increase in the offshore mix sequentially.

* PAT increased 28.7% QoQ to INR3.2b, against our expectation of INR2.5b; this was primarily owing to higher operational income.

* Growth in 3Q was driven by Travel & Hospitality (12.6% QoQ), Retail & Manufacturing (5.5% QoQ), and Technology, Media & Services (5.2% QoQ). The BFSI vertical posted muted growth of 0.9% QoQ.

* In terms of geography, growth was broad-based, with the US growing 4.7% QoQ, while Europe inched up 3.7% QoQ. RoW reported robust growth of 10.9% QoQ.

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