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Neutral Tech Mahindra Ltd For Target Rs.1,220

Improving outlook, but operational metrics stretched

Further re-rating to require consistency in growth

* In USD terms, revenue growth of 3.9% QoQ CC in 1QFY22 was above our estimate mainly on account of Communications (+2.9% v/s expectation of flat growth). The Enterprise business reported a growth of 4.7% QoQ CC. New deal wins fell 20% QoQ to USD815m (0.6x BTB), but stayed ahead of past trends, while the qualified pipeline remained at historical peaks.

* EBIT margin dipped by 130bp QoQ in 1QFY22 (led by wage hike, visa cost and seasonality in Communications), but was 90bp above our estimate. TECHM added 5,200 employees in 1QFY22 (70% in the BPS vertical), although software professionals remained below 1QFY21 levels. Despite this, utilization rose by 100bp to one of the highest levels in our IT coverage (89% excluding trainees).

* TECHM marginally revised up its FY22E revenue growth guidance as it now expects the Communications vertical to grow at double-digits in FY22 (v/s higher single-digits earlier). With healthy deal bookings and highest ever pipeline, we expect TECHM to deliver revenue growth of 13% in FY22, although it will still be the weakest among our largecap coverage universe.

* We expect TECHM to deliver stable to improving margin performance over the next three quarters, although higher attrition (17.2% LTM, +390bp QoQ) and utilization remain a key risk on the downside for margin. We expect a margin expansion of 120bp from FY21-23E, resulting in 18% PAT CAGR over FY21-23E.

* We continue to stay on the sidelines on TECHM as we see its stronger business performance as balanced by elevated operational metrics in a supply constrained environment. We also await clarity on the impact of 5G spend on growth, given the repurposing of budgets in 5G, which should taper down the momentum unlike previous cycles. We raise our FY22E/FY23E EPS estimate by 3-5%. Our TP implies 17x FY23E EPS. We remain Neutral on the stock.

Operations above our estimate; strong headcount addition after five quarters of net decline

* Revenue increased by 14.6% YoY (est. 12.6%), EBITDA grew 44.3% (est. 38%), and PAT rose 39.2% (est. 19.6%) in 1QFY22.

* Revenue grew 4.1% QoQ to USD1,383.6m, which is above our estimate of USD1,360m (+2.3% QoQ) in 1QFY22.

* This implies a CC revenue growth of 3.9% QoQ (estimate organic growth of 3% QoQ CC).

* Communication/Enterprise revenue grew 2.9%/4.7% QoQ CC.

* Growth has been broad based, with Technology/Manufacturing/BFSI/Retail growing at 8.1%/4.5%/3.7%/3.2% QoQ.

* EBIT margin stood at 15.2%, -130bp QoQ, was 90bp above our estimate. The drop in margin was led by wage hike, deal ramp ups, and higher supply cost.

* Employee count grew by 5,200 employees, after a net headcount reduction of 9,780 employees in the past five quarters. Utilization increased by 100bp QoQ, despite a healthy increase in headcount.

* At the same time, attrition has inched up by 400bp QoQ to 17%.

* PAT at INR13.5b (+11.7% QoQ) was above our estimate due to higher operating and other income, and lower tax rate than expected.

* Total net new TCV stood at USD815m, of which USD463m/USD352m was in Enterprise/Communications. Deal wins have been higher than the average runrate of USD400-500m.

* FCF stood at USD172m, implying a FCF/PAT of 92% in 1QFY22.

* DSO increased by a day QoQ at 93 days.

Key highlights from the management commentary

* Telecom companies recognize the need to invest in 5G to generate momentum and are talking about further product development around 5G. This should create more opportunities for the company. Of the new deals, 60-70% already consists of some parts of 5G.

* The management guided at double-digit growth in FY22. This is on the back of a broad based growth across sectors and strong deal wins. The pipeline is robust and at a record high, giving it further confidence.

* The management expects EBIT margin to gradually improve throughout FY22. It is confident of managing cost headwinds (supply-side pressures and return of travel costs), through continued operational productivity. Valuation and view – A further re-rating would require a pick-up in revenue

* TECHM’s high exposure to the Communications vertical remains a potential opportunity as a broader 5G rollout could lead to a new spending cycle in this space. However, significant traction from the same isn’t visible yet.

* We expect a gradual improvement in EBIT margin, given the levers around productivity and cost optimization. Elevated operating metrics and supply-side pressures remain a risk to our margin estimate.

* We expect TECHM to deliver double-digit growth in FY22. However, the extent of the same is likely to be lower than its peers. We value the stock at 17x FY23E EPS. We remain Neutral on the stock.

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