Deal pipeline, recovery in momentum of telecom triggers for Tech Mahindra

In the near term, profitability is expected to be under pressure before recovering in FY21

A large deal pipeline and a recovery in growth momentum for the telecom vertical is expected boost revenue visibility of Tech Mahindra over the next few quarters. The company won deals to the tune of $3.7 billion over the last six quarters and more than half of this was from the communications vertical. Its deal wins were boosted by the AT&T contract in the September quarter. About 40 per cent of the cumulative deal wins over the last six quarters came in Q2.

The deal wins and upcoming contracts in the enterprise and communications verticals is expected to help the company achieve a high single digit (8-9 per cent) growth in FY21. Interestingly, while communications continues to dominate its business mix, the management expects its contribution to come down as the enterprise segment witnesses an uptick in deal size.

Within the enterprise segment, barring auto and banking and financial services, the company has doubled its deal pipeline since the start of the year. About 40 per cent of enterprise revenues are in the digital segment, which has grown at 30 per cent plus rates in each of the last six quarters. The company believes that there are opportunities to improve its footprint in verticals such as retail, travel and transportation as well as energy.

While revenue visibility and growth should hold steady, margins are expected to be soft in the near term. Analysts at Centrum Research believe that there are medium-term margin headwinds for the company from transition costs associated with large deal ramp-up. Sector specific challenges in auto segment, too, are expected to weigh on profitability. While FY20 margins are estimated at just under 13 per cent, the management expects margins to recover in FY21 to 15 per cent levels. This is on the back of higher utilisation and automation, gains from the large telecom deal and improvement in recently acquired companies. The Street would keep an eye out for margins, given its implications for earnings growth.

The positive for shareholders is that the company plans to return excess cash of over $600 million (cash on books at $900 million currently) to shareholders in the form of dividends and buyback, which should help sentiments. 

At the current price, the stock trades at a reasonable 14 times FY21 earnings estimates. While traction in telecom vertical is positive, consistent growth in overall revenues and deal wins are critical for the stock to rerate.