Analyst corner: Tech Mahindra management aims to revert to 15% EBIT margin

TechM reported strong 2Q, with both revenue growth (4.1% Q-o-Q cc) & EBIT margin (12.8%, +130 bps Q-o-Q) ahead of estimates. Deal TCV of $1.5 bn was mainly due to large AT&T deal but even enterprise TCV of $500 mn was higher. Commentary suggested positive outlook across verticals & healthy deal pipeline. It expects EBIT margin to revert to 15% in FY21E vs 12.1% in 1HFY20; even its guidance of 150-250 bps lower Y-o-Y margin in H2 implies sequential improvement.

Tech Mahindra’s 2Q results were well ahead of our estimate as both revenue growth (4.1% Q-o-Q cc vs expectation of 2%) and EBIT margin (12.8% vs estimate of 12%) surprised positively. Strong sequential revenue growth was driven by 5.6% Q-o-Q cc growth in enterprise segment as most verticals, except manufacturing, grew sharply.

Growth in communications also revived to 2.1% QoQ cc. Positive surprise in EBIT margin was partly driven by unusually low SG&A expenses at 13% of revenue vs. typical range guided by management of 13.5-14%; better operational efficiency particularly higher utilisation also helped. Lower taxes due to prior period tax refund, unrelated to recent corporate tax cuts, helped reported PAT further. Tech Mahindra reported a high deal TCV of $1.5bn in 2Q, helped by the large AT&T deal which led to $1bn contribution from communications but even enterprise TCV at $500mn was higher than usual.

The commentary on outlook was positive, with the management indicating a healthy deal pipeline, continued traction across most enterprise verticals and some revival even in the manufacturing/auto vertical, which has been a key laggard, from 3Q.

Management is targeting to revert EBIT margin to 15% in FY21E similar to FY19 vs. 12.1% in 1HFY20. While it expects large deal ramp up to be a drag on margins over the next 2-3 quarters its guidance of 150-250bps lower margin YoY in 2HFY20 implies 13.2% EBIT at the lower end, still a sequential improvement from 2Q, which is a good outcome in our view. TechM announced the acquisition of 100% stake in BORN group, an integrated agency headquartered in New York, which will add to its commerce and customer experience capabilities.