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Results in-line, Re-initiate with ADD rating?

Tech Mahindra reported results with slightly better than estimated revenues of Rs 137,346 mn (+4.6% q-o-q, +19.9% y-o-y) and in-line EBITDA margins of 15.6% (+ 50 bps q-o-q, -240 bps y-o-y). Despite strong deal wins of $795 mn, Tech Mahindra’s management has flagged slowdown in the macro environment, pointing out longer deal cycles, lower discretionary spend and slowdown in smaller deals. The company expects margin improvement to continue via several levers including reduced subcontracting, increased offshoring, pruning non-strategic assets/clients etc. We expect Tech Mahindra’s revenues/EBITDA/EPS to grow by 12%/11%/9% from FY22-25E. We re-initiate on Tech Mahindra with an ADD rating and a target price of Rs 1,121.

Revenue growth slightly better than estimates, management warns of slowdown??????? 

Revenue was Rs 137,346 mn (+4.6% q-o-q, +19.9% y-o-y) slightly better than consensus estimates of Rs 135,226 mn. USD Revenue was $1,668 mn (+1.8% q-o-q, +8.8% y-o-y). Constant currency growth was +0.2% q-o-q, +12.7% y-o-y. Among geographies, Americas degrew by -0.4% q-o-q, while Europe grew by +1.6% q-o-q, and Rest of the World grew at +6.7% q-o-q. Tech Mahindra did flag cautiousness in spending by clients pointing out that it was seeing longer deal cycles, lower discretionary spend and slowdown in smaller deals

EBITDA Margins improve sequentially by +50 bps, in line with expectations

EBITDA margin for the business was 15.6%.PAT was Rs 12,970 mn (+0.9% q-o-q, -5.2% y-o-y) slightly above consensus estimates of Rs 12,937 mn, with a PAT margin of 9.4%. Tech Mahindra defined several margin levers such as reduced subcontracting, increased offshoring, pruning non-strategic assets/clients etc to improve margins further. Voluntary attrition was 17%, down 300 bps q-o-q and the third consecutive quarter of attrition decline Total number of employees were 157,068, which represents a sharp decline of 6,844 (-4.2% q-o-q) over previous quarter .

5G capex and improving synergies from acquisitions should drive revenue & margin expansion – Reinitiate with ADD rating

We view Tech Mahindra as one of the key beneficiaries of increasing 5G penetration globally. The company’s communication, media & entertainment business contributes ~40% of revenues and is well-placed to benefit from increasing number of new deals as 5G rollouts continue globally. Tech Mahindra expects to reach $1bn (~15% of FY23E revenues) of revenue from 5G projects in FY23. We expect growth to be similarly strong in FY24 as 5G penetration increases and more use-cases develop globally. Further, Tech Mahindra has been focusing on improving synergies from a string of acquisitions made over the last 5 years as well as pruning low-margin revenue streams and increasing the share of the high-margin US geography. We expect Tech Mahindra’s revenues from FY22-25E to increase at a CAGR of 12.8% and operating margins to improve to 13.9% by FY25 (from 11.4% in Q2FY23) driven by increasing 5G capex spends and various margin improvement measures. The company currently trades at 13x H1FY25 EPS, while we value the company at 14x H1FY25 EPS, in-line with Wipro which reflects the former’s 5G tailwinds and expected margin improvement. We value Tech Mahindra at a target price of Rs 1,121 and re-initiate with an ADD rating. Key risks to our thesis include lower growth from 5G and delays in margin improvement.

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