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Light at the end of the tunnel

Decent revenue growth in seasonally weak quarter, margin recovery encouraging

* Tech Mahindra (TECHM) reported 1QFY25 revenue of USD1.5b, up 0.7% QoQ in CC vs. our estimate of 0.4% QoQ CC. The weakness was primarily due to a continued slowdown in CME (down 2.0% QoQ). Banking and Technology were flat QoQ, while Manufacturing showed continued strength with 2.4% QoQ growth. EBIT margin was up 110bp QoQ at 8.5% (est. 7.7%). TCV stood at USD534m (+6.8% QoQ/+48.7% YoY). Adj. PAT stood at INR8.5b (est. INR8.1b), up 29% QoQ, due to lower sub-con costs and SG&A costs.

* We remain positive about the restructuring at TECHM under the new leadership and believe this quarter was another step in the right direction. But we expect the impact from these steps to be visible gradually. Further, TECHM’s presence in the communications segment, which remains under notable duress, makes the new management’s job that much harder.

* The recovery in EBIT margin despite the seasonal weakness in 1Q was encouraging, though a meaningful recovery and a return to low-teens margins may still be too early to call. However, bitter pills swallowed in FY24 (exiting unprofitable contracts) are bearing fruit. We expect demand improvement and further push on revenues to be key margin drivers from hereon.

* Our FY25/FY26 EPS estimates remain broadly unchanged. We see FY25E/FY26E EBIT margins at 9.2%/12.4%, resulting in a 25% CAGR in INR PAT over FY24-26E.

* We remain on the sidelines as we feel the current valuation fairly factors in the uncertainties around growth and margin. We remain Neutral on the stock and upgrade our target multiple to 23x FY26E EPS. Our TP of INR1,470 implies a 5% downside.

Slight beat on revenues; margins ahead of estimates

* Revenue stood at USD1.5b, up 0.7% QoQ CC (est. 0.4% QoQ CC).

* IT service growth was down 0.7% QoQ, while BPO grew by 11.0% QoQ.

* CME saw a further decline of 1.9%. Manufacturing was up 2.4% QoQ. BFSI and Technology were flat QoQ whereas retail grew 5.2% QoQ.

* EBIT margin was up 110bp QoQ at 8.5% (est. 7.7%).

* Net employee addition: 2,165 (up 1.5% QoQ). Utilization (ex. trainees) remained flat at 86%. LTM attrition was also stable at 10%.

* NN Deal TCV was USD534m, up 6.8% QoQ/ 48.7% YoY.

* Adj. PAT stood at INR8.5b (up 29% QoQ), above our estimate of INR8.1b.

* FCF conversion to PAT stood at 104% vs. 163% in 4Q.

Key highlights from the management commentary

* TECHM expects the large deal win rate to improve going forward on the back of a good deal funnel. It is focusing on the US, Europe and priority markets in APAC for investments and deal wins.

* Demand remains stable compared to previous quarters; however, it has improved from last year. Demand should pick up in 2H.

* The demand environment in BFSI is reasonably stable. The company has the most experienced and domain-rich talent pool in BFSI compare to the industry.

* In the US, the company is seeing improved spending in compliance, wealth and Insurance segments, whereas IB, mortgage, etc. remain a little soft.

* BFSI is still relatively a small part of the business. Building out a new team to mine the existing accounts, coupled with on-boarding new logos.

* Cybersecurity has remained a focus area for TECHM’s clients.

* Growth was largely broad-based, except telecom, which was hit by seasonality in Comviva business. The company expects FY25 to be better than FY24.

Valuation and view

We remain positive about the restructuring at TECHM under the new leadership and believe this quarter was another step in the right direction. But we expect the impact from these steps to be visible gradually. Further, TECHM’s presence in the communications segment, which remains under notable duress, makes the new management’s job that much harder. We remain on the sidelines as we feel the current valuation fairly factors in the uncertainties around growth and margin. Our FY25/FY26 EPS estimates remain broadly unchanged. We remain Neutral on the stock and upgrade our target multiple to 23x FY26E EPS. Our TP of INR1,470 implies a 5% downside

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