Dear Friends,
We are recommending Buy on our Actionable ViewPoints " Mastek Ltd" as per following:-
CMP: Rs539 Target: Rs 673 (25% Upside)
Key Points:
Mastek Limited: View Point - Growth on fast track
- Strategy reboot started yielding results: Restructuring of the organisation along with the revised strategy of the newly appointed management has helped Mastek Limited (Mastek) to reinstate the company in the growth trajectory. With arresting multiple headwinds in FY2017, Mastek has delivered strong revenue growth of 46% y-o-y (organic growth around 25% y-o-y) and healthy improvement operating margin performance at 12.2% (vs. 8.7% in FY2017) in FY2018. Growth was primarily supported by strengthening the key senior managerial personnel, including the appointment of new CEO Mr. John Owen, who has been directionally executing the strategy with prioritising the agendas such as a) deepening the relationship with U.K. public sector and new logo wins, b) brand recognition in the U.S. and c) M&A activity. We view the renewed strategy enables Mastek to achieve a sustainable improvement in performance and adjust its future growth trajectory.
- Focus on client mining and new logo wins in the U.K.: The introduction of Digital Outcomes and Specialists (DOS) framework by the U.K. government (replacement of Digital Services 2 framework in 2016) for IT vendors has created a good pipeline of opportunities in the public sector for Mastek by working closely (earlier working as a subcontractor for larger players such as BT, Fujitsu and Capita) with the U.K. government. Subcontractor revenue from U.K. public sector to overall revenue has declined substantially to around 3% currently, in-turn Mastek has become a prime vendor of U.K. government's Home Office, NHS Digital and Ministry of Defence, among others. To increase the wallet share from U.K. public sector, Mastek has shortlisted five more departments under the U.K. government to extend its service offerings, of which the company has already secured orders from two departments. Ramp-up of these deals (expects benefits to be seen in the next couple of quarters) along with higher spending on digital technologies by U.K. public sector (spent more than GBP 1 billion across digital services, DOS and G-cloud, as per GlobalData) and its new horizontal service line approach are expected to elevate the revenue growth trajectory in the coming years. In addition, Mastek focuses on increasing revenue contribution from non-public clients in the U.K. by improving new logo wins and cross/up-sell activities.
- To scale business in the U.S. with inorganic acquisition: The acquisition of TaisTech (in December 2016) has helped Mastek to increase brand awareness in the U.S. along with minimising the risk of region concentration. This acquisition along with the appointment of Bob King (as CEO, Americas, Oracle commerce consulting background) has strengthened the company's position in implementing digital commerce platform in the U.S. Notably, TaisTech revenue grew by around 10% in CC terms in FY2018. Further, management aims to enhance its digital commerce offerings by creating complementary capabilities in the areas of UI, UX and CPQ via acquisitions (with a ticket size of around $15 million-$25 million). Post that, the company also plans to acquire digital agency competence. With bringing these capabilities to its service portfolio, the company would be able to provide complete integration offerings to e-commerce retailers. End-to-end solutions to online retail players would create a long-term revenue visibility along with cross-sell opportunities in other key geographies.
- Healthy balance sheet, improving return ratio: Mastek had cash and cash equivalents (including fair value of mutual funds) of around Rs. 200 crore in its books as of June 30, 2018, excluding the holdings in Majesco (13.8% stake in Majesco USA). Investments in Majesco stand at above Rs. 256 crore (20% of Mastek's market cap). Management has indicated that it would not shy out to sell its sale stake in Majesco (~Rs. 256 crore) for its M&A activity. RoE is expected to improve to 17% in FY2020 from 13.7% in FY2018, while improvement in cash conversion would remain robust (expect CFO/EBITDA to be at 0.86x in FY2020 vs. 0.64x in FY2018). DSO stood healthy at 61 days in Q1FY2019 (vs. 67/72 days in Q4FY2018/Q1FY2018, respectively), which indicates strong cash conversion rate (CFO/EBITDA was at 0.62x).
- Margins upward bias to continue: Management remains optimistic on a continued upward bias on margins in the coming years despite investments in sales and marketing, additional onsite resources for digital works and potential future acquisitions. We expect EBITDA margin to expand to 13.5% in FY2020 from 12.2% in FY2018, led by higher revenue contribution from investments on sales resources in the U.S. and higher growth in the digital business. As a result, Mastek's revenue and net profit are expected to report CAGR of 19% and 24%, respectively, over FY2018-FY2020.
- Reasonable valuation versus peers, expect 23-25% upside: We view momentum in organic revenue growth and profitability to continue in the coming years on account of deeper penetration in existing large accounts (especially in the U.K.), new logo wins and strong deal pipelines. Further, the company is scouting for acquisition in the digital commerce space to provide end-to-end solutions to e-commerce players. At CMP, Mastek's stock is trading at 12x P/E and 7x EV/EBITDA of FY2020 estimates, while excluding the investment in Majesco USA (Rs256 crore), stock is trading at much attractive valuation of 9.5x FY20E, which is at a steep discount to average IT mid-cap peers (see peer comparison table). We initiate our viewpoint coverage on Mastek with a Positive stance and expect 23-25% upside over the next 8-12 months, factoring in ~Rs. 75 per share (30% holding discount) from Majesco stake
