Brokerages upgrade Tech Mahindra on Q1 show, double-digit growth outlook

Inexpensive valuations provide support to the stock

The stock of the country’s fifth-largest listed software developer by market capitalisation, Tech Mahindra got a 7 per cent boost on Friday. The gains for the company were on account of better-than-expected June quarter performance with growth across key markets and verticals, robust deal wins and guidance of double-digit growth rates for FY22.

Its revenue growth at 3.9 per cent on a constant currency basis was led by the enterprise and communications segments. The new deal wins with a total contract value (TCV) of $815 million was in line with expectations though higher than its average quarterly deal win TCVs of $400 million to $500 million. The deal pipeline also remains at an all time high despite strong conversion over the last two quarters.

Demand growth is coming from areas such cloud, artificial intelligence, cyber security and data services. Rollout of 5G products/services would be a key trigger for the company; notably over 60 per cent of the deals in communications are related to 5G. Communications, media and entertainment remains the largest vertical contributing about 40 per cent to sales. Analysts led by Mukul Garg of Motilal Oswal Research expect the company to report a growth of 13 per cent on the back of healthy deal bookings and highest ever pipeline.

While revenue growth and deal inflow remained strong in the quarter, operating profit margins declined by 80 basis points to 15.2 per cent on a sequential basis. This was on account of wage hikes, visa costs, seasonal decline in mobility business and higher subcontracting costs. What helped offset these pressures were lower administrative costs, higher utilisation and operating leverage. Despite the pressures, the company indicated that margins for FY22 would remain above the 15 per cent mark. Investors however will keep an eye out for supply side talent and reversal of some savings as travel costs make a comeback.

Dipesh Mehta and Monit Vyas of Emkay Research have raised the earnings per share estimates for FY22-24 by 4.5-5.9 per cent factoring in the beat in the June quarter. They have a buy rating and have raised their target price to Rs 1,480 (from Rs 1,410) considering anticipated acceleration in revenue growth, margin resilience, healthy cash conversion and reasonable valuations. The stock is trading at 17 times its FY23 earnings which is at a discount to larger peers. Most brokerages have a buy rating on the stock with average target price of Rs 1,320, an upside of 9 per cent from the current levels. Consistency of revenue growth and margin improvement would be main triggers for rerating; investors can consider the stock on dips.