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Tech Mahindra (TECHM) delivered a weak 1QFY24 performance, with revenue declining 4.2% QoQ in CC to USD1.6b, missing our estimate of a 2.5% decline. The weakness was primarily due to a slowdown in CME (down 9.5% QoQ), while Enterprise saw a marginal dip vs. 4QFY23. 1Q EBIT margin (adjusted for client-specific write-off) was down 240bp QoQ at 8.8% (est. 10.6%). TECHM delivered weak TCV for the second straight quarter at USD359m, down 39% QoQ after a 25% QoQ decline in Q4.

* Given the slowdown in Communications business across IT services peers in the last few weeks, there was a concern about a weak revenue performance from TECHM. But we were still surprised by the sharp drop in CME vertical (38% of revenues in 1Q) even after adjusting for the Comviva seasonality. While we expect the segment to return to growth in 2Q, we remain concerned about near-term demand in the space, given the adverse readthrough from the global ecosystem, including telecom hardware makers. We factor in USD revenue decline of 7.1% YoY in the vertical in FY24.

* On the other hand, we expect the Enterprise vertical to grow this year by 2.7% YoY in USD, though the weak TCV addition during the last two quarters will remain an overhang. With our base case factoring in a pick-up in FY25, we expect TECHM to deliver a USD revenue CAGR of 4.7% over FY23-25.

* Due to the sharp dip in revenue, TECHM also saw a steep fall in profitability, exacerbated by a 200bp one-time impact from bankruptcy of a client. We expect the company’s profitability to improve from 2Q onward, partially through sharp cost control and headcount cuts despite high utilization. We see FY24E (adj)/FY25E EBIT margins at 10.6%/12.2%, resulting in a muted INR PAT CAGR of 5.5% in FY23-25E despite a low FY23 base (PAT -8.9% YoY).

* While we expect a potential for performance improvement after the leadership refresh in Jun’23, we believe this will take time given the macro headwinds and limited flexibility to invest in growth because of weak current profitability.

* We remain on the sidelines as we feel the current valuation fairly factors in the uncertainties around growth and margin. We cut our FY24/FY25 EPS estimates by 8-10% on weak margin and muted outlook. We remain Neutral on the stock with a TP of INR1,080 (17x FY25E EPS).

Big miss on both revenue and margins

* Revenue stood at USD1.6b, down 4.2% QoQ CC (est. -2.5% QoQ CC decline).

* IT service growth was down 5.0% QoQ, while BPO was up 1.3% QoQ.

* CME saw a significant decline of 9.5%, followed by BFSI down 2.8%. Retail and Technology were flat QoQ. Manufacturing was up 2.0% QoQ.

* EBIT margin was down 440bp QoQ/430bp YoY at 6.8% (est. 10.6%).

* The employee count declined for the third consecutive quarter by 4.1k (- 2.6% QoQ). Utilization (ex. trainees) was up by 100bp QoQ at 87%. LTM attrition improved by 200bp QoQ to 13%.

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