Tech Mahindra posts all-round growth

A strong deal pipeline and pick-up in demand will drive the company's growth, believe analysts

In the footsteps of larger peers such as Tata Consultancy Services and Infosys, Tech Mahindra posted a good set of numbers for the September quarter. It managed to meet Street expectations on all fronts, with revenues better than analyst expectations. Revenues were Rs 4,772 crore, up 16.3 per cent sequentially while net profit grew 4.7 per cent sequentially to Rs  718 crore.

Though a year-on-year comparison is strictly not comparable, given the merger of Mahindra Satyam with the company in June,  consolidated revenues and net profit were up 35.4 per cent and 57.6 per cent, respectively.

The earnings before interest, tax, depreciation, and amortisation (Ebitda) margin expanded 222 basis points sequentially to 23.3 per cent, in line with consensus expectations. While margins were aided by a weaker rupee, the net profit growth was lower than sales growth on account of forex loss of Rs  26 crore. The company had forex gains of Rs 134 crore in the June quarter.

The company remains confident on demand and expects client budgets to remain at the same levels in FY15. It announced two large deals in the enterprise solutions segment (previously Mahindra Satyam) and has a healthy deal pipeline.

Vineet Nayyar, executive vice-chairman, says, "There was a sense of relief when issues related to the fiscal crisis in the US were resolved. There is a resurgence of confidence in European economy. I think the pessimism which came in the last two years has lifted. Our foray into Africa in two-three years will stand us in good stead.”

Most analysts remain positive. Of 31 polled by Bloomberg since September, 28 have buy ratings, two sell and one hold. The average target price is Rs 1,601, indicating a mere 1.3 per cent upsides from Thursday's closing price of Rs 1,580.

Ankita Somani, information technology (IT) analyst, Angel Broking, says, "The net profit is in line with expectations. The dollar-revenue growth exceeded expectations. Operationally, results look good.”

Good growth in key geographies, with Europe reporting 6.8 per cent sequential growth, helped the company post a good increase in topline. The US and the rest of the world grew 1.5 per cent each. Among the key verticals, banking, financial services and insurance (BFSI) grew 5.5 per cent, followed by 3.8 per cent in media and entertainment. Telecom grew 2.7 per cent. The company is focusing on BFSI, manufacturing and telecom. Volume growth was five per cent, better than the three-four per cent expected by analysts, while pricing remained largely stable.

The management said revenues from British Telecom (BT) continued to slide. Those were 12 per cent of consolidated revenues in the June quarter. It believes revenues from BT will be under pressure.

The company has reinvested part of the gains from rupee depreciation to scale deals and revenues, while a part is reflected in margin expansion. It will implement wage rises in January, which could affect margins. However, analysts say margins could hold on.

While Somani says she is likely to marginally raise her FY14 earnings estimates and, hence, the target price could increase from Rs  1,600, in a report last month Morgan Stanley analysts said they expected it to maintain margins in a narrow range in FY14, despite the full impact of lower-margin acquisitions and wage rises that could be offset by rupee depreciation.

“We expect Tech Mahindra’s multiple to re-rate further (to 14 times FY15 estimated earnings per share (EPS) and narrow its discount (10-50 per cent) to larger peers,” Vipin Khare, IT analyst at Morgan Stanley, had noted.

The stock, which has risen from Rs 1,300-1,350 in September to Rs  1,580, still trades at 12 times FY15 estimated earnings against 15.6 times for HCL Technologies and 14.9 times and 19.7 times for Infosys and TCS, respectively.

Among the few downside risks analysts see are earnings dilutive acquisitions, given the company’s aggressive growth strategy that could strain the balance sheet. Also, there is sharp volatility in rupee.