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Transformation on track

Continued recovery in margins accompanied by healthy deal wins

* Tech Mahindra (TECHM) reported 2QFY25 revenue of USD1.6b, up 0.7% QoQ in constant currency (CC) vs. our estimate of 0.2% QoQ CC. The growth was driven by Retail/Technology (up 5.6%/5.7% sequentially). Communication/BFSI also witnessed growth of 2.7%/2.4% QoQ, while Manufacturing declined 4% QoQ. EBIT margin expanded 110bp QoQ at 9.6%, beating our estimates of 9.0%. Adj. PAT stood at INR12.5b (est. INR10b), up 46% QoQ/28% YoY due to operating leverage and higher other income. For 1HFY25, revenue/EBIT/PAT grew 1.1%/13.7%/8.7% vs. 1HFY24. We expect revenue/EBIT/PAT to grow by 4%/44%/27% YoY in 2HFY25. Deal TCV was USD603m, up 13% QoQ/ down 6% YoY. Our view: Disciplined execution

* Growth, excluding manufacturing, was robust: TECHM had broad-based revenue growth, most of which was concentrated in Europe. BFSI was up 2.4%, underscoring the recovery in the sector; that said, persisting weakness in top accounts suggests US communications continued to struggle, and we believe this could be the most significant drag on growth in the near term for TECHM and the industry.

* Healthy TCV despite avoiding large deals: TECHM's deal TCV was up 13% QoQ; while the company continues to be disciplined and looks away from large deals, slowly improving deal activity in short-cycle deals could work in TECHM's favor.

* Transformation in progress: We believe Tech Mahindra’s Phase 1 transformation is progressing well, with EBIT margins likely to exceed 12.7% by FY26. However, the period from FY26 to FY27 may bring renewed margin pressures across the industry, including rising attrition rates, high costs associated with backfilling roles, and increasing demand for specialized talent. These factors could complicate the company’s ability to achieve its FY27 EBIT margin target of 15%.

* Market’s faith in the new management being vindicated: We believe despite the challenges, the new management has repaid the initial faith in its ability to engineer a turnaround. TECHM could be valued at a higher multiple to its historical average. We raise our target multiple to 25x (23x earlier) Sep’26E EPS, which is now at a 10% discount to Infosys.

Valuation and change in estimates

* Change in estimate for FY25 (increase by ~8%) is due to higher other income in 2Q – resulting from exceptional gains on sale of property (operating estimates largely unchanged). We expect FY25/FY26/FY27 EBIT margins at 9.2%/ 12.7%/13.1%, which will result in a 20% CAGR in INR PAT over FY24-27.

* We remain on the sidelines, as we believe the current valuation fairly factors in the uncertainties around growth and margin. We reiterate our Neutral rating on the stock and upgrade our target multiple to 25x Sep’26 EPS. Our TP of INR1,700 implies a 1% upside.

Beat on revenue and margins; broad-based growth (ex-manufacturing)

* Revenue stood at USD1.6b, up 0.7% QoQ CC, beating our estimates of 0.2% QoQ CC.

* IT service growth was up 2.3% QoQ, while BPO grew 2.9% QoQ.

* Retail/Technology led the growth by +5.6%/+5.7% sequentially, whereas Communication/BFSI grew 2.7%/2.4% QoQ. Manufacturing dipped 4% QoQ.

* EBIT margin was up 110bp QoQ at 9.6%, beating our estimates of 9.0%.

* Net employee addition: 6653 (up 4.5% QoQ). Utilization (ex. trainees) was up by 20bp at 86.3%. LTM attrition was up by 50bp at 10.6%.

* NN Deal TCV was USD603m, up 13% QoQ/ down 6% YoY.

* Adj. PAT stood at INR12.5b (up 46% QoQ / 28% YoY), above our estimate of INR10b.

* FCF conversion to PAT stood at 106% vs. 104% in 1Q.

* The Board announced an interim dividend of INR15 per share. Key highlights from the management commentary

* Demand remains largely unchanged. The company has been focusing on strengthening client relationships and expanding the partner ecosystem.

* The second half of the fiscal year is expected to be better as the foundation for a turnaround has been established.

* Steady progress is being made on long-term metrics: three pillars—growth, margins, and organizational excellence.

* Growth: Accounts with revenue exceeding USD20mn have grown significantly. The company is investing in account-based marketing through turbocharged programs and training for technical and marketing architecture. Organizational: Cultural transformation is underway, with progress in generative AI skills; onethird of the workforce is using GitHub Copilot.

* Large deal wins are a key factor for growth, and the company is investing in developing large deal capabilities. Conversion rates have improved due to the quality of technical solutions. The company is investing in deal architecture and negotiators for better conversion rates.

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. We reiterate our Neutral rating on the stock and upgrade our target multiple to 25x Sep’26 EPS. Our TP of INR1,700 implies a 1% upside.

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