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Multiple positives except for softness in deal wins
However, rich multiples leave no margin of safety
* Strong growth at top account (+26% YoY) and better-than-expected operational optimization assuage concerns about ownership and management transition. Early signs of success related to strategy refresh (e.g. increasing revenue share from fixed-price contracts) are now visible.
* As mix incrementally shifts toward annuity revenue, we see headroom for further
(i) utilization improvement,
(ii) pyramid correction and
(iii) reduction in sales intensity. However, the impact of this should be offset by correction in higher yields(vs. peers). The recent sharp rally in the stock price and rich multiples (19x one year forward P/E) already factor in the key positives, in our view. Maintain Neutral.
Surprise on margins, top account growth
* Revenue was up 9.4% YoY to USD275m (marginal miss). EBIT declined 2.4% YoY (our estimate: -18%) and PAT increased ~14% YoY to INR1,970m (our estimate: -3.2%).
* This was led by sharp growth acceleration at top account (26% YoY v/s 12% YoY in 2Q), despite the recent transition in account management.
* Share of revenue from fixed-price contracts increased ~280bp QoQ to ~59%, reflecting the progress on strategic re-alignment toward annuity revenue.
Strong beat on EBIT margin was driven by better-than-expected operational optimization and projects moving from transition to steady state.
* However, both new deal wins and renewals during the quarter disappointed.
Company is optimistic on deal closures, further margin expansion
* Softness in deal signings is due to deferrals in decision making driven by furloughs. However, MTCL continues to see positive deal momentum and is optimistic about deal closures in 4QFY20.
* Current EBIT margins (12%) are sustainable. More importantly, MTCL reiterated its emphasis on further margin improvement in a gradual manner. We build in 120bp margin expansion over FY20-22.
* Incrementally, focus will be on managed services/annuity based revenue.
* Tail account rationalization initiatives will continue for a few more quarters.
Valuation view – cautious on softness in deal wins and high multiples
* Historically, difference in business mix translated into bloated employee cost due to
(1) lower utilizations and
(2) higher sales intensity. Employee + subcon expenses formed 71% of revenue v/s 66% for LTI (last three year avg.).
* In that context, the shift in business mix toward more of manage services should translate into headroom for
(1) utilization improvement,
(2) pyramid correction and
(3) reduction in sales intensity.
* However, the impact of this should be offset by correction in higher yields (MTCL has 9%-10% higher revenue per utilized tech emp. v/s LTI).
* The recent sharp rally in the stock price and rich multiples (19x one year forward P/E) factor in the key positives and do not leave any margin of safety. Given the softness in deal wins this quarter and increasing client concentration, we await a better entry point.
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