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Communications to remain a drag on FY22E performance

Further re-rating to require a pickup in growth

* TECHM’s 4QFY21 USD revenue growth of 0.7% QoQ CC was below our already modest expectations. Communications was flat during 4QFY21, while the Enterprise business posted modest growth (1.1% QoQ CC). New deal wins of USD1.04b was the highest in five quarters and split equally between Communications (driven by the Telefonica deal win) and enterprise. EBIT margin increased by 60bp to a multi-year high of 16.5%, unlike our expectation of a 20bp QoQ dip. Increase in margin was led by further rationalizing of headcount (847 employee reduction), while maintaining peak utilization levels (87%). For FY21, sales (USD)/EBIT/PAT moved by -1.4%/26%/5%.

* The management guided at low double-digit growth in FY22, with doubledigit growth in enterprise and high single-digit growth in Communications. It indicated strong deal momentum in 1QFY22, led by a strong deal pipeline. It also reiterated its view of delivering at least 15% EBIT margin in FY22.

* TECHM’s FY22E revenue growth and EBIT margin guidance were on expected lines, with the gap between enterprise and Communications growth continuing for another year. Despite a healthy order book and good demand commentary, single-digit growth in Communications would remain a key overhang on the stock’s performance. With TECHM’s FY22E revenue growth lagging behind its peers (FY22E organic USD growth of 10% being the weakest in our coverage), valuation should stay rangebound, despite being at a significant discount (below 15x FY23E P/E) to its peers.

* While TECHM’s margin performance has been excellent, we see elevated risk on account of its stretched supply-side position. It should face a higher impact from expected tightening in talent supply in CY21-22 due to less aggressive talent interventions v/s peers, who have proactively offered variable pay and a full wage hike.

* As operations are running at elevated levels (higher utilization, lower employee expenses, etc.), we expect some normalization in EBIT margin from current levels. This should lead to the lowest PAT growth among its peer group. We largely keep our estimates unchanged post its 4QFY21 result. Our TP implies 16x FY23E EPS. Remain Neutral.

Weak topline, beat on margin

* TECHM’s 4QFY21 revenue grew 1.6% QoQ to USD1,330m, which is below our estimate of USD1,343m.

* This implies CC revenue growth of 0.7% QoQ.

* Both Communications and enterprise saw a muted performance, growing by 0.2% QoQ CC and 1.1% QoQ CC, respectively.

* Among verticals, growth was majorly led by BFS at 4.9% QoQ. Other verticals posted sub-2% QoQ growth. Retail, Transport, and Logistics fell 3.2% QoQ.

* EBIT margin at 16.5%, up 60bp QoQ and 80bp above our estimate were helped by a very strong BPO margin (28% EBITDA).

* Employee count fell for the second straight quarter (-847 QoQ) despite higher utilization (87%).

* PAT of INR10.8b (-17.4% QoQ) was 15% below our estimate due to impairment of goodwill, forex losses, and higher tax rate (INR793m pertaining to an earlier period). Excluding the tax impact and impairment, PAT stood at INR12.1b, an increase of 19% YoY.

* Total TCV stood at USD1,043m (a five quarter high), of which USD525m/USD518m was in enterprise/Communications.

Deal wins in Communications were boosted by a large deal with Germany’s Telefonica.

* FCF in 4QFY21 stood at USD187m (a 7% YoY gain), implying a FCF/PAT of 127%. For FY21, FCF stood at USD965m (an increase of 85% YoY), implying a FCF/PAT of 162%

* DSO at 92 days was the lowest in four years.

* LTM attrition increased 100bp sequentially to 13%.

* The company announced a final/special dividend of INR15/share each. For FY21, total dividend/payout stood at INR45 per share/89%.

* During 4QFY21, TECHM has announced three acquisitions: 1) 70% stake in Perigord Asset Holdings (USD25), 2) DigitalonUS (total consideration of USD120m), and 3) EventUs Solutions (total consideration of USD44m).

Key highlights from the management commentary

* TECHM reported net new deal wins of USD1.04b in 4QFY21, with deals being divided equally between Communication and Enterprise. The uptick in deal wins is very encouraging. The management expects a similar momentum in deal signings going into 1QFY22 as well. It expects double-digit growth in Enterprise and high single-digit growth in Communications.

* EBIT margin in 4QFY21 stood at 16.5%, the highest reported margin in the last six years. The expansion was driven by operational efficiencies, delivery transformation comprising of offshoring, and increased automation. Lower depreciation, due to conservative capex spend, during FY21 also aided margin. However, these were partly offset by an increase in SG&A costs, mainly in recruitment costs.

* The company has started rolling out wage hikes effective 1st Apr’21 and alluded that it would impact its 1QFY22 margin. It also rolled out a special additional variable payout to some employees. However, the management stated that they would mitigate this impact by improving operational levers. Despite the return of costs, it is confident of reporting an EBIT margin of over 15% in FY22.

Valuation and view – A further re-rating would require a pick-up in revenue

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

* While EBITDA margin has seen a very strong improvement, the management has maintained their 15% guidance band (with an upward bias). For normalization of EBITDA margin, it would need to invest back in the business (utilization, employee wage hikes, etc.) after keeping a tight leash on the same during FY21.

* We expect TECHM to deliver double-digit growth in FY22E. However, the extent of the same is likely to be lower than its peers. We expect some normalization in margin, which would lead to a lower P/E multiple. We value the stock at 16x FY23E EPS, a 40% discount to our target P/E for TCS. Remain Neutral.

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