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Portfolio pruning may continue in FY24; valuations inexpensive

* TECHM reported a revenue of USD1.63b in 2QFY23, up 2.9% QoQ in CC terms v/s our estimate of 2% QoQ. Reported growth was muted at 0.3% QoQ in 2QFY23, led by BPS (up 3.6% QoQ), while IT Services were flat QoQ. EBIT margin rose 40bp QoQ to 11.4% (in line), despite wage hikes.

* Revenue growth in 2QFY23 was impacted by 100bp (annual run-rate of USD60m) due to TECHM’s account pruning program to exit low margin and non-strategic accounts. The management indicated a total annualized impact of USD100-120m in FY23, implying another 100bp hit over 2H. Moreover, higher furloughs in 3QFY23 may further impact revenue.

* We expect TECHM to deliver a USD revenue growth of 9.7% in FY23 (including ~400bp from the inorganic route), which is among the weakest in our Coverage Universe. It should see continued pressure in FY24 as its focus on margin may be at the cost of growth. We continue to expect positive commentary on 5G spends to play out over the medium term on account of growth and monetization uncertainty on the telco side. TECHM should deliver a USD revenue CAGR of 90% over FY22-24.

* We remain concerned about TECHM’s weak margin performance in 1HFY23, which makes it unlikely to meet its previous exit margin guidance of 14%. With incremental pressure from an adverse operating leverage in 2H, we expect it to exit FY23 with an EBIT margin of 13.2%, which will make it difficult to deliver a meaningful margin recovery in FY24 (MOFLSe of 12.6%).

* We remain on the sidelines on TECHM as we feel the current valuations fairly factor in uncertainties around growth and margin. We marginally tweak our estimates to account for lower margin. Our TP implies 15x FY24E EPS. We remain Neutral on the stock.

Good performance in 2QFY23 driven by the BPS business

* Revenue grew 0.3% QoQ to USD1.63b (up 2.9% in CC terms v/s our estimate of 2%).

* In USD terms, revenue grew 15% in 1HFY23. In INR terms, EBIT/PAT fell 9% each.

* FCF to PAT conversion stood at a strong 159% in 2QFY23. ? EBIT margin (adjusted for one-off impairment) grew 40bp QoQ, but fell 380bp YoY, to 11.4% (in line).

* Adjusted PAT rose 15.8% QoQ to INR13.1b, ahead of our estimate of INR12.3b on account of a lower tax rate.

Key highlights from the management commentary

* Revenue was impacted by 1% due to TECHM’s portfolio pruning program to exit low margin, non-strategic, and low-return accounts.

* Of the total USD120m accounts identified as part of the portfolio pruning program, USD60m, on an annualized run-rate basis, has been trimmed in 2QFY23 (largely in BFSI). The remainder of these accounts will be trimmed in 2HFY23 and have a 30-40bp impact each in 3Q and 4Q.

* The management indicated lots of uncertainty on margin in 2HFY23 on account of growth, furloughs, and currency-related movements.

Valuation and view

* Though its current performance remains muted, TECHM’s high exposure to the Communications vertical offers a potential opportunity as a broader 5G rollout can result in a new spending cycle in this space.

* We expect TECHM to deliver muted growth in FY23. We value the stock at 15x FY24E EPS. We maintain our Neutral rating.

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