EBIT margin contracted 220bps q-o-q to 10.0% (est. of 12.0%). TechM margin recovery plan gets derailed due to Covid-19 impact. Margin drivers include reduction in sub-con, vendor management, cut in variable pay and bonus.
We maintain BUY on Tech Mahindra despite lower than expected revenue and margin performance. The telecom growth recovery (+6.8% y-o-y CC in FY20) is slightly derailed due to Covid-19 impact and near-term supply side challenges, but the medium term growth driver remains on track. Positives include leadership position in telecom, 5G opportunity (slightly delayed) and higher synergies between enterprise and telecom. Margin remains a challenge for TechM and the recovery planned for FY21E shifts by one more year. We have cut EPS est. by 6.0/5.7% for FY21/22E and ~31% correction in 3M factors most of the negatives. Our TP stands at `625 based on 13x (~6% discount to 5Y median) FY22E EPS.
Revenue stood at $1,295 million (-4.3% q-o-q, -3.3% CC), which was below our est. of $1,331 million. TechM growth was impacted due to sharp drop in telecom while enterprise revenue was in line with expectation. Enterprise (59% of revenue) was down 1.3% q-o-q led by TME (-6.8%), retail (-3.0%) and manufacturing (-2.1%) offset by BFSI (+10.9%). The enterprise segment will have some impact of lower discretionary spending. Highest impact will be felt in manufacturing and retail, while lower exposure to energy and travel & transport will limit downside. Large deal ramp-up (albeit slow) in BFSI will support growth.
Telecom growth was impacted due to BPM (-15.6% q-o-q), delay in network roll out services and weak Comviva. Large global players’ focus remains on network modernisation, ops transformation and 5G roll-outs. These spend could be delayed, as currently the focus remains on keeping the lights on, implementing WFH and data security. BPM is facing supply side challenges (~75% WFH) and Q4 had only two weeks impact.
EBIT margin contracted 220bps q-o-q to 10.0% (est. of 12.0%). TechM margin recovery plan gets derailed due to Covid-19 impact. Margin drivers include reduction in sub-con, vendor management, cut in variable pay and bonus. Cash generation improved, DSO days, including unbilled came down to 102 days. OCF/Ebitda improved to 76.1% in FY20 vs. 69.9% in FY19.
Growth recovery in telecom and enterprise, large deal wins and margin stability achieved in the first three quarters of FY20, gets derailed in Q4 in light of Covid-19 uncertainty. Downtrend will continue in H1FY21 and discretionary spending will get impacted in the near term. Pricing pressure, furloughs and delay in spend will impact growth and margins in FY21E. We expect these factors to subside in FY22E and TechM can be a beneficiary of vendor consolidation in telecom segment, where it is an undisputed leader. We expect dollar revenue growth of -4.7/+6.8% in FY21/22E. TechM trades at a P/E of 12.9/11.4x FY21/22E (~18% discount to 5Y median).