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Back to Margin improvisation levels again!

TechM’s 1QFY23 reflects strong and balanced revenue growth across Communications and Enterprise business. However margins slipped sharper than expected (note that margins have been coming off for 3 quarters in a row!) with a 220 bps sequential drop on account of seasonal factors (Visa, Comviva) along with higher subcontracting, deal transition and normalisation in SG&A(+100 bps). Profits thereby came in lower due to margin miss and lower other income despite favourable ETR relative to expectations. Headcount addition continues to be decent although is skewed in favour of BPM unlike recent quarters. Net new Deal wins continued to be in the USD 800Mn-USD 1 bn range with TechM expecting margins to exit FY23 with EBIT margins of 14% citing likely benefits from optimising utilisation and subcontracting expenses along with pricing leverage (company saw ~50 bps benefit in 1QFY23 as well!). That said, 1Q miss drive 3-6% EPS cuts across FY23-25E. We continue to maintain BUY with a revised TP of INR 1,210 (based on a revised PER of 17x, at a historical 40% discount to TCS PER) V/s INR 1,340 earlier(based on 18x)

* Slight revenue beat; margins disappoint: TechM reported a 3.5% sequential c/c revenue growth ahead of both JMF(+3.2% QoQ)/consensus(2.8%QoQ). Growth was well balanced across Communications (+3.9% QoQ c/c) and Enterprise (+3.2% QoQ c/c) akin to the trends witnessed through recent quarters. Amongst verticals, growth was strong across all major verticals with the exception of BFS and Others. Margins however disappointed yet again, coming off by 220 bps sequentially , lower than estimates due to multiple factors(visa, Comviva seasonality, normalisation of SG&A, deal transition and higher sub contracting). Headcount addition remained strong with TechM adding ~6.8k employees at a net level though hiring was skewed in favour of BPO unlike recent quarters and was lateral heavy on the IT Services side. Deal wins remained in the USD 800Mn-USD 1bn /quarterly range though company has discontinued splitting order intake between Communications and Enterprise from the current quarter.

* Remains confident of near term growth; targets margin improvement: Akin to peers, TechM also suggested that it has not seen any deterioration in demand (strong pipeline, deal conversions, ‘no budget reductions’) despite worsening macro and believes that recent order bookings take care of near term revenue growth visibility. Further TechM expects to improve margins through every single quarter for the rest of FY23 and despite upcoming annual wage hikes in 2QFY23(~100 bps as per company unlike peers which have seen higher impact). TechM expects to focus on improving utilisation, pushing higher offshore mix and course correcting on higher subcontractor expenses.

* 1Q miss drive 3-6% EPS cuts: We cut FY23-25E EPS by 3-6% driven by lower margins and 1Q miss. Maintain BUY with a revised TP of INR 1,210 (V/s 1,340 earlier) based on a revised PER of 17x(V/s 18x earlier), based on average 40% historical discount to TCS. While TechM’s execution remains below par relative to peers, we keep faith in potential margin improvisation given sharp declines in recent quarters.

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