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Steady revenue performance; EBITM misses expectations

* Tech Mahindra’s Q1FY23 revenue was broadly in line with our expectations, but EBITM missed our estimates. Revenue grew by 1.5% QoQ to USD1,632mn (3.5% CC), led by CME (3.9%) and Enterprise (3.2%). EBITM declined 220bps QoQ to 11%.

* Net new deal wins were robust with a TCV of USD802mn in Q1. The deal pipeline remains healthy across the CME and Enterprise segments, and the company expects steady deal closures and revenue conversion to continue.

* Management remains confident of sustaining revenue growth momentum on the back of broad-based demand, healthy deal intake and strong deal pipeline. It believes EBITM has bottomed out in Q1 and expects 100-150bps sequential margin improvement in every quarter for the next three quarters, leading to an exit quarter margin of ~14%.

* We cut our FY23/FY24/FY25 EPS estimates by 3.3%/1.8%/0.3%, factoring in the Q1 performance. Sustained revenue growth momentum, management guidance on margin recovery and 4%+ dividend yield make the risk-reward favorable, in our view. We maintain Buy with a TP of Rs1,240 (Rs1,260 earlier) at 17x Jun’24E EPS.

What we liked? Broad-based revenue growth, healthy deal intake, moderation in attrition (22.2% vs. 23.5% in Q4), and steady progress across client buckets.

What we did not like? EBITM miss and weak cash conversion (OCF/EBITDA: ~47%).

Steady revenue growth in Q1; growth momentum to continue: Revenue grew by 1.5% QoQ to USD1.63bn in Q1 (3.5% CC), in line with our expectations. Revenue growth was driven by CME (3.9% QoQ CC) and Enterprise businesses (3.2%). The CME business continued to see traction, thanks to Cloud AI-Ops and 5G-led digital transformation spends. Enterprise business revenue growth was led by Technology (6.4% QoQ CC), Retail, Transport & Logistics (6.8%), Manufacturing (5.7%), and Others (2%), while BFSI remained flat. Geographically, growth was led by Americas (4.0% QoQ CC), Europe (3.9%), and RoW (2.4%). Data engineering, cloud, experience, data analytics, and AI/ML continued to drive transformation demand. The deal intake in Q1 was healthy, with net new TCV of deals at USD802mn. Management remains fairly confident of sustaining revenue growth momentum on the back of broad-based demand, robust deal wins and a strong deal pipeline. Management remains watchful given the dynamic global macro environment and will continue to invest in new and emerging technologies to deliver differentiated offerings. TechM has seen steady progress across client buckets in Q1, with USD20mn+ and USD10mn+ client counts increasing by 6 and 7 QoQ, respectively.

Q1 margin misses estimates: EBITM declined by 220bps QoQ to 11% on an uptick in employee costs due to continued interventions amid tight labor markets, subcontracting costs and large deal transition costs (-100bps), uptick in visa costs and mobility seasonality (- 80bps), and higher SG&A (-100bps), partly negated by pricing benefits (+50bps). Salary hikes wef July (-100bps) remain a margin headwind for Q2, which management expects to offset by better pricing (at least +50bps); lower visa and large deal transition costs; higher utilization; pyramid rationalization; and offshore shift. Management believes that margins have bottomed out in Q1 and expects 100-150bps QoQ improvement in every quarter for the next three quarters, leading to an exit quarter margin of ~14%

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