CMC Ltd : BUY

Interim Hiccups; An Opportunity to Buy

Transformation accomplished: FY11 marked first full year post CMC’s biz transformation, in which it delivered healthy topline growth (+24% YoY) with stable margins (FY11 OPM at ~19%; +40 bps YoY). A balanced rev mix (Svcs: ~89%, International revs: ~54%, contribution from TCS: ~47-48% in Q4F11) with ~30% segmental PBIT margins for high growth Systems Integration & ITES biz (FY11 aggregate share: ~68%) bestow a positive demand outlook for CMC in the coming years.

Long-term revenue visibility robust: Higher employee additions (+33% YoY to 7,396) & increased investments in facilities are direct indicators of a stronger revenue outlook in the coming years. Healthy demand outlook is also reflected in new client additions (20 in Q4 – 8 in US and 12 in India/ 80 in FY11). In domestic biz (Q4 rev share: ~46%), CMC is witnessing strong traction in its niche verticals/offerings — Infra, e-Governance, Insurance, Retail (Rollout svcs), Rural & Co-operative Banks, Mobile and Cloud Computing. In exports (+26% YoY in Q4), strong demand is witnessed in its key offerings – Embedded & Real-Time Systems, Digitization & Work-Flow mgmt – in developed (US/Europe) as well as in emerging economies (Bangladesh, Sri Lanka, Nepal and MEA).

Leverage on short-term corrections (due to higher FY12E tax rate and capex) to BUY: FY12E tax rate and 35% increase in SEZ capacity to impact short-term performance. CMC’s earnings growth would have been higher but for increase in the FY12E effective tax rate to 25% (vs. earlier indications of 20%) and higher capex of ~Rs 250 cr in FY12E. Commencement of Phase III facility with 3,500 capacity addition (+35%) to Phase I & II (10,000 capacity) to impact cash flows in FY12E. On the positive side, this increase in capacity is again an indicator of buoyant demand. While we reduce our FY12E EPS est. downwards by ~10% to ~Rs 132 to incorporate these changes, we remain more confident on FY13E EPS growth and build in ~28% YoY growth to Rs 169. Revenue/PBT CAGR btw FY11- FY13E at 24%/23% resp.

BUY the stock from a long-term perspective.