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Solid growth, but stretched metrics adds to the risks

Margin to remain flat, despite a step up in growth

* USD revenue growth of 7.2% QoQ CC in 2QFY22 was above our estimate, led by broad based growth within both Communications/Enterprise (+7.7%/+7% QoQ CC). New deal wins fell 8% QoQ to USD750m, but stayed ahead of past trends. The management continues to see sustained traction in deal win momentum.

* EBIT margin was flat QoQ (40bp above our estimate) in 2QFY22, with the benefit from operating leverage offset by utilization and subcontracting cost. TECHM had a record high net addition of ~15k employees in 2QFY22. While utilization dipped 100bp, it is still at the highest level in our IT coverage (89% excluding trainees).

* The management commentary on sustained deal win momentum and revenue growth remains strong. With healthy deal bookings, robust pipeline, and strong net additions, we expect TECHM to deliver organic CC revenue growth of 13.8% YoY in FY22.

* EBIT margin is likely to remain stable in 2H and FY22, despite support from growth, as stretched operating metrics and supply-side challenges leave little room for expansion. Higher attrition (21% LTM, +400bp QoQ) and utilization remain a key risk on the downside for margin and constrain operational flexibility. We expect 80bp margin expansion over FY21-23E, resulting in 20% PAT CAGR over FY21-23E.

* We continue to stay on the sidelines on TECHM, as we see its strong business performance balanced with elevated operational risks in a supply constrained environment. While commentary on 5G remains upbeat, we await further clarity on the sustained 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 6%/4%. Our TP implies 22x FY23E EPS. We remain Neutral on the stock.

Operations above our estimate, strong headcount addition

* Revenue rose 16.4% YoY (est. 13.2%), EBITDA grew 17.2% (est. 13.4%), and PAT increased by 25.7% (est. 19.1%).

* Revenue grew 6.4% QoQ to USD1,473m, which is above our estimate of USD1,432m, in 2QFY22 (+3.5% QoQ).

* This implies a CC revenue growth of 7.2% QoQ and 15.5% YoY.

* Communications/Enterprise revenue grew 7.7%/7% QoQ CC.

* USD revenue/INR EBIT/INR PAT grew by 16%/42%/32% YoY in 1HFY22.

* Growth performance within Enterprise has been broad based, with Technology growing at 8.9% QoQ, Retail at 7.8%, Manufacturing at 3.2%, and BFSI at 5.8%.

* EBIT margin was flat QoQ at 15.2%, above our estimate of 14.8%. Margin was aided by operating leverage, offset by lower utilization and higher subcontracting cost.

* The net addition of 14,930 employees was at a record high. Utilization dipped by 100bp QoQ, led by strong headcount addition.

* At the same time, attrition inched up by 400bp QoQ to 21%.

* PAT fell 1.1% QoQ to INR13.4b, but was above our estimate due to higher revenue and better margin.

* Total net new TCV stood at USD750m, of which USD495m/USD255m was in Enterprise/Communications. Deal wins have been higher than the average runrate of USD400-500m. 

* FCF stood at USD188m in 2QFY22, implying a FCF/PAT of 114%.

* DSO decreased by a day QoQ to 92 days.

Key highlights from the management commentary

* TECHM reported net new deal wins of USD750m in 2QFY22. The company’s deal win momentum has accelerated v/s its historical average of USD450-500m. The management sees sustained and broad based acceleration in the deal pipeline. It expects the deal win momentum to continue.

* Within Communications, strong growth of 7.7% QoQ cc was led by traction from 5G engagements and modernization of legacy systems to Digital. The ramp up of large deals contributed to the strong growth in communications. 5G is witnessing an improving contribution to the deal pipeline, deal bookings, and revenue. The management expects this trend to continue. Overall growth momentum in Communications is expected to continue.

* The management has maintained its double-digit organic growth guidance for FY22. Traction is broad based growth across sectors. Strong deal wins and robust pipeline will aid the continued growth momentum.

* Revenue growth and offshoring are one of the key margin levers. Supply-side challenges and wage inflation is being offset by fresher intake.

* Margin enhancement for portfolio companies is in the WIP stage, and the management expects to continue to derive gradual benefits from it.

* It has maintained its EBIT margin guidance of ~15%. Supply-side challenges will continue to act as a margin headwind. Moreover, costs can gradually increase from 2HFY22.

Valuation and view

* TECHM's huge exposure to the Communications vertical remains a potential opportunity as a broader 5G rollout can lead to a new spending cycle in this space. The company is seeing traction in 5G investment.

* 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 estimates.

* We expect TECHM to deliver mid-teens growth in FY22. We value the stock at 22x FY23E EPS. We remain Neutral on the stock.

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