OW on Tech Mahindra as stock undervalued

Written by Morgan Stanley | Updated: Aug 31 2013, 14:56pm hrs
Tech Mahindra
We resume coverage on Tech Mahindra (TechM) with an overweight rating and a price target of R1,650 per share. We believe revenue growth over next 2-3 years could surpass our and Street expectations.

We expect TechMs multiple to rerate further (our price target implies 14x FY15e EPS) and narrow its discount (10%-50%) to larger peers. Despite its sharp move (+65%) over the past 12 months, the stock price could see further P/E rerating, in our view, as the company delivers revenue growth in line with industry. We believe treasury stock could be used for margin-dilutive acquisitions, with upside risks to our estimates.

We expect Tech M to deliver FY14-15 revenue growth in line with industry. TechM exhibited strong execution in improving margins in FY13. Key FY14 focus area remains topline growth, according to management. We expect the company to achieve a ~15% FY13-15 dollar revenue CAGR, despite drag from its largest client, BT Group. Consensus projects a 12% $ revenue CAGR.

Further, we expect TechM to maintain margins in a narrow range in FY14, despite the full impact of lower-margin acquisitions and wage hikes that could be offset by rupee depreciation.

Any of the following could help the stock to re-rate further: (a) revenue growth and margin surprise could help narrow the valuation discount to peers; (b) if management uses treasury shares for acquisitions, it could be EPS accretive; (c) acquiring other Mahindra Group IT companies to build scale and dividend payout could increase from 6% currently to industry average of ~20%-30% of profits.