Tech Mahindra Ltd Records Disappointing Operating Performance

BUY

CMP: Rs1003 

Target Price: Rs1170

TechM delivered a weak operating performance in Q4FY23. Revenue stood flat QoQ at USD1,668mn (0.3% CC QoQ), driven by CME (1.8%), while Enterprise declined by 0.7% QoQ. EBITM declined 80bps QoQ to 11.2%. Revenue growth was led by CME (0.7% in USD), Manufacturing (1.5%), BFSI (0.3%), and Others (2.7%), while Retail, Transport and Logistics declined 10.4% sequentially. Among geographies, Europe led the growth, at 3.5% QoQ, while Americas and RoW declined 0.3% and 2.9%, respectively. Net new deal wins came in at USD592mn, lower than the prior quarters, reflecting cautious approach by clients considering macroeconomic uncertainties. Management highlighted the macro environment remains challenging and the company is witnessing slower decision making, with discretionary spend and transformational deals witnessing an additional layer of decision making. Management expects growth to remain soft in H1FY24 and anticipates improvement in H2FY24, based on its conversations with clients. Increasing offshoring, pyramid rationalization, structural actions to divest non-profitable businesses, and optimizing sub-contracting cost remain the levers for margin expansion in the medium term. We have cut our EPS estimates for FY24/25 by 7.3-13.7% to factor in the Q4 miss and lower margin assumptions. Considering inexpensive valuations and a ~5% dividend yield, we retain our Buy rating on the stock with a TP of Rs1,170 at 16x Mar-25E EPS (earlier Rs1,270).

Result summary: TechM reported revenue of USD1.67bn, flat QoQ (CC 0.3% QoQ), a tad below our expectations of USD1.69bn. CME delivered resilient performance on account of continued strength in 5G and network. Enterprise reported weak performance on account of the decline in Retail, Transport and Logistics and flat performance in BFSI and Technology. EBITM declined 80bps QoQ to 11.2% due to currency headwinds (-60bps) and higher SG&A expenses (-90bps), partly offset by operating efficiencies and lower subcontracting costs (+70bps). Net profit stood at Rs11.18bn. Headcount declined for the second consecutive quarter, down by 4,668 in Q4 to 152,400. Utilization at 86% was flat sequentially. The number of USD5mn and USD10mn clients increased by 1 and 3, respectively. Revenue from the top-5 clients declined for the fourth consecutive quarter, down 5% QoQ. Net new deals for the quarter came at USD592mn, the lowest in the last nine quarters. The company declared a final dividend of Rs32/share, taking the total dividend for FY23 to Rs50/share. What we liked: Resilient CME performance, attrition moderated to 15% in Q4 vs. 17% in Q3. What we did not like: Margin miss and back-ended growth recovery expectations in FY24.

Earnings call KTAs: 1) Management stated macro uncertainties prevail and some customers are slowing down their spending. Discretionary spends and transformation deals are going through an additional level of decision-making. The pipeline is skewed more towards cost-takeout deals. 2) Robust pipeline, positive client conversations, and encouraging technology metrics give medium-term optimism to the management. 3) Management expects some carry-forward impact of price hike benefits in FY24, but it is limited compared to FY23. 4) Wage hikes would be staggered across quarters in FY24. 5) TechM expects revenue growth and margin trajectory to be better in H2FY24 vs. H1FY24, which is likely to be soft. 6) Margin levers are flattening pyramid, offshore shift, exiting low-margin business, automation, better business and geo mix, and optimization of sub-contracting costs. 7) SG&A grew in Q4 due to continued investments in business taking a longer-term view. Management expects SG&A costs to normalize to ~13.5% of revenue. 8) LTM attrition trended downwards to 14.8% for Q4 vs. 17.3% for Q3. 9) DSO stood at 96 days. 10) Hedge book at Q4-end stood at USD2.3bn.