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Analyst meet takeaways: no significant change in earnings growth profile

We attended Tech Mahindra (TechM) Investor Day 2023, wherein management outlined the company’s focus areas: 1) Growth levers, viz. large transformation deals, and deeper alliances and partnerships. 2) Build technology competencies via investing in ‘products and platforms’ (7% of revenue) and co-creating solutions with client partners. 3) Emphasis on operational rigour to improve margins. 4) Talent transformation. We believe TechM is investing in the right areas, but we do not expect material addition to revenue growth in the medium term. We continue to assume 8.3% USD revenue CAGR over FY23E-FY26E driven by 8.6% CAGR in enterprise segment and 7.8% in communications segment over the same period.

We continue to value TechM at 14x FY26E EPS of Rs76 (discounted back 1-year with WACC of 12%) to arrive at our 12-month target price of Rs971 (unchanged), implying 11% potential downside. Stock price has run up ~8% in past one month in anticipation of potential leadership change. TechM is now trading at 16x/14x on FY25E/FY26EPS. We downgrade the stock to REDUCE (earlier: Hold) as we do not expect earnings fundamentals to materially change over next three years despite potential leadership change (we assume 10.1% EPS CAGR over FY23E-FY26E, lowest in our coverage universe), because we believe EBIT margins will likely remain range-bound around 12- 13% over FY23E-FY26E due to the need to invest in digital capabilities. Plus, TechM’s wallet share in top-5 clients has been reducing for past four quarters and this is likely to continue over the next two quarters as well due to increased level of automation and cost-reduction programmes undertaken by these clients.

TechM management outlined its investment focus areas and key strengths:

* Improving margins over next three years: For TechM, FY23 margins were impacted by: i) high wage inflation and strong net headcount addition, ii) acquisition payouts, and iii) large deal transition costs. In FY24, management expects to improve margins led by: i) operating efficiencies, ii) portfolio rationalisation and earn-out reduction, and iii) reduction in SG&A costs. However, large deal transition and wage hike impact could continue to be headwinds as per management. For two years beyond FY24, management plans to improve margins led by business and geo mix changes and normalisation of large deal costs and operating efficiencies, while wage hikes and SG&A investments will be the key headwinds

We believe, operating metrics – offshore mix and utilisation – are largely at optimum levels (charts 7, 8) and there is marginal scope for further improvement. In addition, investments in building digital competencies, partnerships and alliances will be key headwinds to margins apart from the usual annual wage hikes. Therefore, we have assumed only a modest improvement in EBIT margins from 11.8% in FY23E to 12.7% in FY26E.

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