Tech Mahindra’s Q4FY16 revenue at $1,023m (up 0.8% q-o-q and 1.3% in CC) was in line with Street’s estimate (0.5%), while Ebdita (earnings before depreciation, interest, taxes and amortisation) margin at 16.9% (16.5% estimate) was slightly above it on account of lower sub-contracting cost and sharp employee cut. Key highlights: (i) telecom/non-telecom posted flat/ 1.6% revenue growth; (ii) flat Ebdita margin q-o-q in spite of wage hike; and (iii) management’s positive outlook on the currently decelerating telecom business. We believe our thesis that TECHM will recoup margin should play out hereon as wage hike is behind and positive commentary on telecom implies growth acceleration. Maintain Buy with a TP of R658 (16x FY18e EPS).
Flattish telecom revenue a positive: TECHM’s telecom vertical posted flat revenue q-o-q and non-telecom business revenue grew 1.6%. We believe this is encouraging given pressure on the telecom vertical further accentuated by LCC. While BFSI and ROW revenue jumped 9.0% and 7.3%, US and Europe dipped 1.3% and 0.6%. The company anticipates slight decline in telecom vertical in Q1FY17 due to Comviva seasonality, but believes LCC at current rate of $320m has bottomed out.
Flat margin implies full absorption of wage hike impact: The company posted flat Ebidta margin q-o-q aided by efficiency, shedding of LCC business and currency benefits. TECHM has lost 600bps margin over the past 2 years on account of acquisitions and higher onsite mix. We reiterate our view that the company will recoup a large part of lost margin with acceleration in revenue and change in onsite mix.
Outlook and valuations: Attractive; maintain Buy: Full absorption of wage impact in Q4FY16 vindicates our bullish stance on margin. This, coupled with revival in telecom business led by one large deal win and calling off of merger in another deal will accelerate telecom revenue along with further improvement in margin. Ergo, we estimate EPS CAGR of 13.9% over FY16-18. We maintain ‘Buy/SP’ as valuations at 11.7x FY18e EPS provide favourable entry point.
Why we like the stock: TECHM has been plagued by weak revenue and margin contraction. Revenue weakness is on account of telecom vertical and slower-than-anticipated traction in the enterprise vertical. Margin contraction is due to acquisitions and changing business mix. We expect revenue growth to gain traction hereon due to bottoming out of LCC business, closure of one large deal in the M&A space and calling off of merger between Vodafone and O2. TECHM also expects at least 1 more large M&A deal to close in Q1FY17.
Margins on upmove…..loss-making businesses chopped off: Margins over the past two years have been dented by 600bps. The impact (160-170bps) was on account of acquisition of Sofgen and LCC. As these acquisitions have a large onsite component, it resulted in change in business mix with onsite increasing 10%. TECHM has already rationalised the acquired LCC business by chopping off low-margin business by 20% and believes the remaining part will not only grow but clock margin improvement.
Better growth and margin improvement scenario: We believe closure of one large deal in the M&A space by TECHM and cancellation of merger in other large deal will lead to revenue spurt, which had stagnated in the past few quarters. The above, coupled with bottoming out of LCC business, implies no negatives in the telecom business.
Chopping off of LCC’s low margin business implies no more dent to the company’s overall margin and revenue acceleration-based operating leverage should play out in coming quarters. We, in spite of huge margin levers like significant rationalisation possibility in the onsite business mix, are building in conservative margin of 17.0%/17.5% over FY17/18.
Revenue above estimate: Consolidated revenue, at $1,023m, rose 0.8% q-o-q above Street’s estimate of 0.5% q-o-q growth. In INR terms, revenue stood at R6,880 crore, up 2.7% q-o-q.
Ebitda stood at R1,160 crore, up 2.2% q-o-q, while Ebitda margin at 16.9% came marginally ahead of Street’s 16.5% estimate.
PAT, at R890 crore, beat Street’s estimate of R7.4 bn, helped by R569.5m write-back of excess tax provision for contingencies provided earlier.
Client data: Active clientele stood at 807 versus 801 in the previous quarter. The number of $20m clients jumped by 3 to 40, while $10m and $50m clients were flat at 63 and 14, respectively.
Employee metrics: Net increase in headcount declined by 1,705 during the quarter, due to reduction of 1,025 and 703 personnel in BPO and IT services. Total headcount stood at 105,432.