Setback for Tech Mahindra shareholders as share price price falls 4 pct, but CLSA has this to say
Management’s comment about a potentially higher capital return is positive for Tech Mahindra.
For Tech Mahindra, CLSA raised their FY21 / FY22 EPS estimates 8% / 5% and increased their target price from Rs 1000 to Rs 940. Management’s comment about a potentially higher capital return was also a positive for Tech Mahindra. ICICI Securities says BPO margins were significantly ahead of pre-Covid level (+760 bps, vs CY19) indicating some mix rationalisation effort is underway. Motilal Oswal says Margin expansion of 410 bps sequentially was a surprise. This was led by improvement in supply / demand and operational efficiencies coming into play.
Focussed on execution
Q2 21 showcases strong margin expansion and improved capital return
Tech Mahindra’s Q2 21 results were similar to peers: a beat on revenue growth (2.9% QoQ growth in constant currency (CC)), strong cost control (14.2% EBIT margin was at a six-quarter high) and healthy cash generation (FCF in first half FY21 itself was more than that of FY20). While its revenue trajectory could remain below peers, at least in the near term, its confidence in sustaining improvements in its margin and cash conversion have legs and should keep its earnings upgrade cycle rolling. Management’s comment about a potentially higher capital return was also a positive for Tech Mahindra.
Deal wins and pipeline recovery likely to show up in revenue with a lag.
Net new deal wins in Q2 FY21 (total contract value of U.S. $ 421 mn) were equally spread across telecom and enterprise segments. Tech Mahindra expects revenue momentum to stay healthy in the near term with seasonal strengths in BPO and mobility businesses though manufacturing vertical (16% of revenues) could remain a drag. Tech Mahindra is optimistic on the 5G opportunity but time lines of its visible revenue impact remain uncertain.
ICICI Securities highlights the key rationale behind BUY rating on Tech Mahindra with target price of Rs 1155. The key reason was the potential surprise on the pace of margin expansion. EBITDA margin expansion of 390 bps QoQ came in significantly ahead of consensus estimates. It was also broad based with both IT services (+290 bps QoQ) and BPO (+15 pp QoQ) reporting healthy expansion. Easing of supply bottlenecks aided the sharp bounce back in margins / revenue of BPO. BPO margins were significantly ahead of pre-Covid level (+760 bps, vs CY19) indicating some mix rationalisation effort was underway.
Tech Mahindra margins should expand further led by more tailwinds from:
(1) Headcount reduction in IT services
(2) Mix rationalisation.
Skewed growth due to RoW across geographies and BPO across services was the key negative in the result. Accounting for supply normalisation, demand in key geographies looks sequentially deteriorated.
Key reason to remain buyers is:
(1) Headroom for margin expansion
(2) Undemanding valuations
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Motilal Oswal remains neutral on Tech Mahindra with a target of Rs 940. Tech Mahindra’s revenue growth of 2.9% QoQ CC was ahead of our expectations (1.5% QoQ). Growth was driven by the Enterprise business (4.3% QoQ) while Communications remained largely flat (0.8% QoQ) given the overhang in Network services. BPO (31.3% QoQ), which accounts for 10% of the business drove more than half of the growth. Margin expansion of 410 bps sequentially was a surprise. This was led by improvement in supply / demand and operational efficiencies coming into play.
New deal wins of U.S. $421 mn were up sequentially. But, they were impacted by delays in a few large deals and remained below average TCV in FY20 (U.S. $900 mn).
As the business is running at elevated operational levels (utilization, employee expenses, etc.), Motilal Oswal expects limited room for expansion in EBITDA margin (v/s FY21 guidance of 15%).
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