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Improving business traction
We maintain BUY on Tech Mahindra based on higher than expected revenue and profits in 3QFY20. Growth visibility has revived for Telecom and Enterprise segment based on strong TCV wins for the second consecutive quarter. We increase earnings est. for FY21/22E by 3.5/4.7% based on better visibility and margin recovery. Our TP stands at Rs 910 based on 15x (~10% premium to 5Y avg.) Dec-21E EPS.
HIGHLIGHTS OF THE QUARTER
* Revenue stood at USD 1,353mn (+5.1% QoQ, +4.3% CC), which was above our est. of USD 1,323mn. TechM posted the highest CC growth in Tier-1 IT and was led by 8.9/2.4% QoQ growth in Telecom and Enterprise.
* Enterprise (57% of rev) was up 2.4% QoQ (on a strong 2Q) due to growth in BFSI (+6.7% QoQ), Retail (+8.1%) and Manufacturing (+1.0%) offset by TME (-1.4%). Healthy Enterprise TCV of USD 1.1bn (highest ever) bolster confidence and was led by USD 0.9bn multiyear multi services Insurance deal.
* Telecom growth was higher than expectation due to strong ramp up in AT&T deal. Telecom pipeline remains strong as large services providers are driving efficiencies and modernising their existing networks.
* Digital (41% of rev, +40.5% YoY) remains the key strength while legacy was down 7.8% YoY. The acquisition of Cerium Systems is for capability. It has revenue of USD 15mn (+48% YoY) with 850 employees. The deal was valued at 3.2x and has rev/emp of USD 18K. BPS is growing strongly (+11.8% QoQ) led by Telecom. FCF improved to 118% of PAT.
* EBIT margin contracted 58bps QoQ to 12.2% (vs. est. of 12.2%) led by large deal transition cost. Margin Impact of higher SG&A/Sub-con +15.4/+15.2% QoQ was offset by better Utilisation (+200bps QoQ) and currency. Margin in 4Q will be impacted due to transition cost of large BFSI deal. Margin trajectory will improve in FY21E. Attrition dropped to 20% after five quarters.
Better outlook, TCV improving Revival in Enterprise coupled with Telecom traction (large deal win and healthy pipeline) is supporting growth. BFSI growth will continue led by strong deal wins, Healthcare and TME will recover gradually. Manufacturing will stabilise led by growth in process industry and Auto sector pain is behind. The synergies between Telecom and Enterprise are now visible and can lead to large multi year transformational deal wins. We expect USD revenue CAGR of 7.9% over FY19-22E led by Telecom/Enterprise CAGR of 8.3/7.7%. TechM trades at a P/E of 14.6x FY21E (in line with Tier-1 median P/E). The risks to our thesis include deterioration in US/Europe macros, Brexit, trade wars and delay in 5G spend.
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