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Long due and protracted recovery

Tech Mahindra (TechM) witnessed the long awaited and protracted recovery with revenue run-rate just crossing its pre-covid level (US$1,353mn in Dec-19) in Jun-21. Company has been lagging the industry on pace of recovery over the previous three quarters (Sep-20 to Mar-21). Organic growth was estimated at 3% QoQ (CC). Despite the first salary hike in two years, margin management (-130bps QoQ) was noteworthy.

After almost seven quarters, there was decent headcount addition. However, this was driven by BPO (+8% QoQ) rather than IT Services (+2% QoQ). IT headcount is still 4% lower than pre-covid level. With IT utilisation (89%, extrainees), attrition (17%, LTM) running high and travel costs expected to return, sustainability of the current headcount levels and margins (on CC basis) needs to be seen. Net new deal wins (US$815mn vs US$1,043mn in Mar-21) was healthy.

However, their translation into future growth is the key monitorable given the limited causality in the past. Organically, the company should clock ~11.5% YoY (CC) growth in FY22E - implying an underwhelming CAGR of 5% over FY20-FY22E. As investor focus shifts away from mere recovery in FY22E to sustainable growth in FY23E and beyond, we await further clarity on fundamental catalysts, e.g. pick-up in enterprise 5G spends. Reiterate HOLD for now.

* Beat on revenue and margin estimates. Both organic and overall revenue growth at 3% and 3.9% (QoQ, CC) respectively were ahead of consensus estimates. While communications, media and entertainment grew 2.9% QoQ (CC), enterprise grew 4.5% QoQ (CC). Within enterprise, growth was broad based across verticals with technology (+8.1% QoQ, USD) being a key growth driver. Both the key geographies (Americas and Europe) reported strong growth (~7% QoQ, USD). This was partly aided by softness in these verticals over the previous three quarters and the protracted recovery they had witnessed. Notably, even after this quarter, revenue run-rate in Americas is still lower than the pre-covid level (Dec-19), while in Europe it is marginally ahead. Across service lines, BPO continued to outperform. EBIT margin was 80bps ahead of consensus estimates. Despite the first salary hike in two years, margin management (-130bps QoQ) was good. Gross margins contracted 200bps QoQ. Part of this impact was offset by SG&A rationalisation. Higher than expected forex, other income and lower than expected ETR led to strong EPS beat.

* Await further clarity on fundamental catalysts like enterprise 5G spends. Net new deal wins (US$815mn vs US$1,043mn in Mar-21) was healthy. However, their translation into future growth is the key monitorable given the limited causality in the past. Organically, the company should clock ~11.5% YoY (CC) growth in FY22E - implying an underwhelming CAGR of 5% over FY20-FY22E. As investor focus shifts away from mere recovery in FY22E to sustainable growth in FY23E and beyond, we await further clarity on fundamental catalysts like pick-up in enterprise 5G spends. Reiterate HOLD rating for now.

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