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Less dependence on UK, currency headwinds abating: retaining a Buy

Mastek’s Q2 was weak as it continued to face challenges in UK Healthcare, US Retail and Manufacturing & Tech, some further accentuated by crosscurrency. However, the company is now stabilizing with drags in healthcare behind, Metasoftech fully integrated from Q3, raising the US contribution to ~27%, and cross-currency turning supportive. While Q3 would be stable, growth is likely to improve from Q4. With annual increments and the worst of attrition behind, EBITDA margins should improve gradually. We reduce our FY23e/FY24e PAT, and TP to Rs2,280 (16.5x FY25e) but retain our Buy

Healthcare stable, UK government business maintaining pace. Mastek’s Q2 revenues were down 1.1% q/q (organic est.), but y/y up 1.1 % (organic est.), to $78m. The key reason was the weak UK healthcare account which shrank in the last two quarters, but has now stabilized. Excl. Healthcare, Government and Education are doing well and uncertainty surrounding the new leadership seems behind. Besides, a sharp rebound in the pound and euro vs the dollar, reversing the trend of the last two quarters, benefits companies with greater exposure to Europe. Reflecting these trends, we expect the Q3 order backlog to improve sequentially

Supply side challenges abating, margins to stabilise. The Q2 FY23 margin was 17.8% (down 134 bps q/q, 331bps y/y, adj for forex loss) hurt by increments in Q2 and drop in utilization to a low 67.8% (down 90bps q/q, 510bps y/y). Offshoring (by effort) was down 210bps q/q to 73.7% (190bps y/y) and is unlikely to be a lever in the short term. Slow hiring, however, will continue with improving utilisation offering tailwinds. Attrition is trending down and is likely to further ease. Overall, margins should hold within the 18-19% band ahead.

Estimates, target lowered. We lower our FY23e/FY24e ~1%/3%, adjusting for the weak performance. Q3 is likely to be stable and we expect the company to return to growth in Q4 as some of the wins start ramping up. On a CC basis, Mastek is likely to report ~12% (organic) growth in FY23. We also introduce FY25e and roll forward our valuation, leading to a revised target of Rs2,280. The stock now trades at 13x FY25 P/E, which we find attractive. Our target is based on 16.5x FY25EPS. Risk: M&A integration-related.

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