Buy Tech Mahindra: Performance was better than estimated

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New Delhi | Published: February 18, 2019 3:11:34 AM

Margins are expected to be range-bound; growth in communication will offer upside; TP raised to Rs 860.

market, tech mahindraTowards end-FY17, TECHM articulated its 6-8 quarter journey for margin improvement.

TECHM’s revenue grew 4.2% y-o-y (our estimate: +2.7%) to $1,261 m, Ebitda increased 36% y-o-y (our estimate: +34%) to Rs 17.2 bn and PAT grew 28% y-o-y (our estimate of flat growth) to Rs 12.0 bn in Q3FY19. CC revenue grew 4.3% q-o-q (+6.4% y-o-y; our estimate: +2.6% q-o-q , +4.7% y-o-y) in the quarter. Gross margin shrank 100bp q-o-q to 33%. However, Ebitda margin expanded 50bp q-o-q to 19.3% (above our estimate of 18.9% by 40bp), driven by lower SGA (-150bp q-o-q to 13.8%; our estimate: 15.3%). PAT increased 27.7% y-o-y to Rs 12.0 bn, higher than our estimate of Rs 9.38 bn (28% beat), led by lower forex losses (`0.8 bn v/s our estimate of `1.9 bn) and lower ETR (17.8% v/s our estimate of 25%).

Broad-based growth, BPO skew continues

Barring TME (-0.8% q-o-q), revenue growth was broad-based (2.5%-6.7% q-o-q) across verticals. Growth continued to be led by BPO, which formed 28% of incremental revenue in the quarter and its revenue contribution inched up to 8.4% from 6.4% in Q1FY18. BPO skew of the recent quarters is also reflected in the headcount—since Q4FY17, software services professionals headcount is down by 10,618 (13%), while BPO headcount is up by 15,025 (53%).

Expect range-bound margins, continued momentum in Communications

Towards end-FY17, TECHM articulated its 6-8 quarter journey for margin improvement. Ebitda margin since then has ramped up from 12% to 19.3% in seven quarters. Going forward, while there are levers such as subsidiary profitability, business mix and yield management, the pace of uptick is likely to be much slower than earlier. Revenue momentum in Communications should continue led by the recent deal wins.

Valuation view

Led by above-estimate revenues and yet another quarter of healthy deal wins, our FY20/21 revenue estimates are up 1%. We expect the margins to remain in the current range (18-18.5%), implying no material change to our earlier estimates (+10bp/20bp for FY20/21). TECHM trades at 14x/12.7x FY20e/21e earnings. The stock has nearly doubled over the past 18 months led by strong margin execution, and we believe that further upside will be a function of continued acceleration in Communications vertical revenue. Near-term upside will be limited, given that there is still time for impetus from 5G to play out, and earnings growth should settle down after the margins’ run. Our TP of Rs 860 (15% upside) discounts forward earnings by 14.5x, the average multiple over the last five years. Maintain Buy.


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