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Disappointing margin performance; Deal intake remains healthy

* Tech Mahindra’s Q4FY22 revenue came in line with our expectations, but EBITM missed our estimates. Revenue grew 4.9% QoQ to USD1,608mn (5.4% CC), led by Enterprise (5.8%) and CME (4.8%). EBITM declined 160bps QoQ to 13.2%.  Net new deal wins were robust with a TCV of USD1,011mn, split across CME (USD645mn) and Enterprise (USD366mn). FY22 deal intake grew ~48% YoY to USD3.3bn. The deal pipeline remains healthy, and it expects healthy deal win momentum to continue.

* Management remains confident of sustaining revenue growth momentum on the back of broad-based demand, solid traction in the CME biz (uptick in digital transformation demand led by 5G spends), healthy deal intake and deal pipeline, and robust demand for digital engineering, cloud, data analytics and cyber security services.

* We cut our FY23/FY24 EPS estimates by 7.5%/6.8%, factoring in the Q4 performance, recent acquisitions, and lower margin assumptions. Strong revenue growth momentum and a ~4% dividend yield will support valuations, although the stock lacks near-term triggers after a big miss on margins. We maintain Buy with a TP of Rs1,600 (Rs1,730 earlier) at 22x Mar’24E EPS.

What we liked? Strong revenue growth, healthy deal intake (~USD1bn vs. ~USD0.7bn in Q3); stable attrition at 23.5% with quarterly annualized attrition moderating for second quarter in a row

What we did not like? EBITM miss; sequential decline in Retail, Transport & Logistics and Manufacturing vertical revenues

Strong revenue growth in Q4; growth momentum to continue: Q4FY22 revenues grew 4.9% QoQ to USD1.61bn (5.4% CC), in line with our expectations. Revenue growth was led by the Enterprise business (5.8% QoQ CC). CME maintained its revenue growth momentum and grew by 4.8% QoQ CC. The CME business continues to see traction thanks to 5G-led digital transformation spends. Revenue growth in Q4 was led by BFSI (18.4% QoQ), Technology (15.1%) and CME (4.1%) verticals, with areas of digital engineering, cloud, data analytics and cyber security seeing healthy traction. In Q4, the company signed net new deals worth USD1,011mn (USD645mn in CME and USD366mn in Enterprise) and the deal pipeline remains robust. Management indicated that the company has addressed most of the white space opportunities through M&A for now and that the focus is now on the integration of these acquisitions and driving synergy benefits in FY23. Management remains fairly confident of sustaining revenue growth momentum on the back of broad-based demand, robust deal wins, strong deal pipeline and contribution from M&As. BFSI, Manufacturing, High-Tech and Healthcare verticals offer significant growth opportunities, and management sees potential to scale up the revenue run rate to over USD1bn for each.

Q4 margin misses estimates: EBITM declined by 160bps QoQ to 13.2% due to lower utilization (due to recruitment for growth and higher fresher intake), supply-side issues (skill-based salary hikes and retention costs), higher D&A charges (additional hardware/software spends and higher amortization charges on account of acquisitions) and the absence of one-off benefits in SG&A expenses of last quarter. Wage hikes (to be done in tranches with a significant tranche in July), visa costs (25-30bps impact in Q1FY23) and expected normalization of travel costs and SG&A expenses are the potential headwinds for FY23, which management expects to be partly offset by revenue growth-led operating leverage, employee pyramid rationalization, subcontracting costs optimization, increase in utilization (85-88% targeted range), higher pricing, and offshore shift. Management aspires to reach ~15% EBITM by FY23-end.

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