Tech Mahindra share price

 Tech Mahindra - 3QFY23 Result Update

Strong Performance…Cautious Outlook

                                                                      TECH MAHINDRA 

Tech Mahindra (TechM) reported revenue of US$1,668mn (up 2% QoQ/up 9% YoY), 1% higher than our estimates of US$1,650mn. Sequential constant currency growth came in at 0.2%, vs. our estimate of 0.5%. The company won net new deals worth US$795mn, compared to US$716mn in 2QFY23. EBIT margin came in at 12% (up 80bps QoQ /down 284bps YoY), vs. our estimate of 11.7% due to better operating leverage, controlled hiring (net employee reduction) and lower sub-contracting expenses. Sub-Con Exp/Sales fell 100bps QoQ to 14.4%. However, higher Other expenses due to travelling cost and increasing overheads with rising office working nullified the benefit. Other exp/Sales grew 160bps QoQ/250bps YoY to 18.7%. Net income stood at Rs12.9bn (up 1% QoQ/ down 5% YoY), vs. our estimate of Rs13bn, due to higher interest expense. Management indicated despite current healthy deal wins, higher level of uncertainty and delay in decision making in US, UK, Germany and few other parts of Europe may impact execution over near to medium term. Management commentary this time was much more cautious and sounding challenging business environment in FY24. Though, we expect uptrend in technology spending to continue but industry would record low double digit revenue growth, due to global slowdown and deferment on technology spending by few telecom players in US. Moreover, TechM may underperform due to higher exposure to slowing Telecom sector. In view of limited margin expansion (much lower than previous peak), lower earnings growth and likely valuation contraction, we maintain our SELL rating on TechM with a revised TP of Rs1,010, (vs. earlier Rs980), valuing stock at a revised P/E multiple of 14x on FY25E earnings.

Retail, transport & logistics and RoW Remained Strong

1) Among verticals, the revenue growth was led by Retail, transport & logistics (6% QoQ), Technology (3.3% QoQ) and CME (1.9% QoQ). 

2) Among geographies, revenue growth was particularly strong in Row (6.7% QoQ) and Europe (1.6% QoQ). 

3) TechM’s total headcount stood at 1,57,068 (net reduction of 6,844 employees, primarily in BPO in 3QFY23. LTM attrition declined to 17% (vs. 20% in 2QFY23).

EBIT Margin to Expand to 13% in FY25E

EBIT margin came in at 12% (up 80bps QoQ /down 284bps YoY), above our estimate of 11.7%. We expect a margin headwind to continue in 4QFY23 due to a higher SG&A cost and overall slowdown in few verticals and few geographies coupled with furlough impact. We believe that likely US recession and global slowdown would impact IT services to some extent and their revenue growth as well as margin territory in next 1-2 years. We expect company’s operating margins to expand from current level due to ease on supply and declining attrition, while global slowdown ahead and likely delay in execution ahead would limit the margin expansion, keeping it way below previous peak. We estimate an EBIT margin of 11.7%/13.4%/13% in FY23E/FY24E/FY25E.

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Valuation and Outlook

Management remains confident of sustaining revenue growth momentum, given broad-based demand across verticals, decent deal wins and a healthy deal pipeline. However, we expect CME vertical to witness rough patch, especially Telecom vertical. Moreover, we expect deferment in IT spending by few telecom clients in US amid likely slowdown/recession ahead. We believe that IT Services would not remain immune to worsening global macros in terms of rising inflation, economic slowdown, cross currency movements and likely cut on spending. We expect company’s Revenue/EBIT/PAT to clock CAGR of 9%/8%/4% over FY22-FY25E. Stock is currently trading at a valuation of 15.2x FY24E and 14.4x FY25E, making risk reward adverse. Revenue growth would taper down to single digit in FY24E, and we expect QoQ decline in deal win, and lower pricing power going ahead which would impact company’s performance.

Conference Call – Key Takeaways 

The revenue grew by 0.2% QoQ and 12.7% YoY in CC terms. The company indicated that delivery transformation, cost optimization and cash conversion would be the key focus area, as they continue to offset the other headwinds in the market. Company is facing challenges in deal to revenue conversion for top clients. Revenues from its top 5 clients and top 10 clients declined 15.2% YoY/4.6% QoQ and 6% YoY and 1.4% QoQ in 3QFY23, indicating weakness in business of large clients.  In 3QFY23, net headcount declined by 6,844 employees to 1,57,068, primarily in BPO services (-7% QoQ), while it marginally declined in IT Services (-2% QoQ). LTM attrition in IT business fell down to 17% in 3QFY23 vs 20% in 2QFY23 and 24% in 3QFY22.  Free Cash flow stood at US$31mn which is 20% of the PAT, some of the billings were impacted by furloughs and FX impact of revaluation.  Hedge book stood at US$2.5bn at 3QFY23-end vs. US$2.4bn in 2QFY23.  New deal wins for the quarter stood at US$795mn vs. US$716mn in 2QFY23. The management expects demand uptrend to continue going forward due to continuous focus on connectivity experiences, cloud and engineering, while near term execution may witness hurdle due to delay in decision making and ramp down in few ongoing projects also.  The company’s tax rate for the quarter stood at 27% vs. 21.9% (lower due to certain one-off) in 2QFY23. The company expects its ETR to be ~25-26% on the normalized basis.

Key Risks: - Lower cut in technology spending than expectation by the large US Clients  Sharp Global economic turnaround at faster than expected pace resulting in faster project ramp-up and completion.  Success of continued cost efficiency projects and lower attrition, lower retention cost  Favorable currency movement. No recession in US in FY24.