Following our interaction with Tech Mahindra (TECHM) management, we see the start of FY18 marred with challenges as revenue headwinds compound profitability stress. Seasonality in the products segment (Comviva), continued rationalisation of the LCC portfolio and tail effect from ramp-down in an account were all known headwinds to communications revenue in Q1FY18. However, we do not expect any offsets alleviating the impact.
Even the Enterprise segment has revenue gap to fill from the transformation projects that ended in Q4FY17, and any offsets there too may have to wait at least for a quarter. We model 1.3% decline in dollar revenues, 5.7% cut. This models organic CC revenue decline of 3.4% q-o-q from headwinds in both the business segments. Q1FY18 will only account for two months of revenues from the integration of HCI acquisition.
We build a partial recovery on the growth front starting Q2FY18, culminating in FY18/FY19 revenue estimates cut of 3.3%/2.0%. Consequently, our earnings estimates are lower by 5.7%/2.6%, partially also on the back of modeling a stronger rupee. After a margin shock in the previous quarter and anticipated revenue growth challenges in the current quarter, the extent of revival in Q2 becomes a barometer of TECHM’s business stability.
Hopes are hinged on the deal wins, which continue to be relatively healthy, and should feed into sanguine revenues beyond Q1, barring unforeseen ramp up challenges. Our estimates are building revenue growth of 3.4% q-o-q in Q2 and EBITDA margin expansion of 90bp to 13.3%. TECHM remains the most inexpensive of the top-tier IT, with valuations of 12.7x FY18E and 10.8x FY19E. However, earnings are expected to decline 4.6% in FY18 after a 9% fall in FY17.
This decline models a pick-up in business momentum from Q2FY18, failing which, the picture would appear worse. There is little in the form of potential triggers given the current state, and the reversal is subject to improvement in the business health from Q2FY18. We had cited our expectation of a gradual margin recovery post Q1, and revenue to follow similar trend. Our price target of `465 discounts FY19E earnings by 13x, implying 20% upside. Maintain Buy.