At 13 times its FY21 EPS, TechM stock is available at attractive valuations

How Tech Mahindra's telecom segment pans out is what the Street is cautious about

After two quarters of weak performance, Tech Mahindra’s (TechM) December 2018 quarter (Q3) results beat the Street’s expectations on all fronts. Its revenue moved up 4.3 per cent sequentially in constant currency (CC) terms, versus analysts’ expectations of around 3 per cent, thanks to its key telecom segment.

Having over 40 per cent share in overall earnings, revenue for the telecom segment rose 2.6 per cent sequentially. How this segment pans out is what the Street is cautious about.

The management is hopeful of supportive performance by the sector, led by 5G. “Outlook for the communication sector is strong. This is a year of foundation and trials for 5G. Next year is when a full-scale spend in 5G will happen,” said C P Gurnani, Director and CEO of TechM.  The company also won $ 250 million (over 55 per cent of its total deal wins of $450 million), in Q3.  

Besides telecom, all other verticals such as manufacturing, retail, BFSI and Healthcare grew 1.4-7.6 per cent sequentially. Revenue growth also came in from a 10 per cent sequential rise in digital revenue, which accounts for 33 per cent share in overall revenue.

This, along with lower operating expenses (selling, general and administrative expenses dropped 146 basis points sequentially to 14 per cent of revenue), and utilisation helped improve profitability.

Tech M’s EBIT (earnings before interest and tax) margin stood at 16.1 per cent, 80 bps higher than Q2, and around 60 bps ahead of analysts’ estimates. In fact, the EBIT margin was highest in the last 15 quarters. Some analysts believe shrinkage in the loss-making LCC business, which was acquired in FY15, supported improvement in margins.

However, manpower cost pressures amid a revival in demand, and foreign exchange losses, among others, contained the margin improvement. This could put further pressure on Tech M, just like its peers.

At 13 times its FY21 earnings per share estimates, the stock — at a 24 per cent discount to Infosys — is available at attractive valuations.