One-off expenses pull down TechM show

However, healthy revenue momentum and easy stock valuation are key positives

Tech Mahindra posted good operational results for September quarter (Q2). The company's sequential dollar revenue growth of four per cent came ahead of Street expectations of 2.5-3 per cent. Revenue was driven by acquisitions as well as healthy traction in manufacturing, communications, and BFSI verticals, which together contribute 79 per cent to Tech Mahindra's revenues. BFSI is banking, financial services, and insurance. Consolidation of Pininfarina, BIO Agency, and Target acquisitions contributed 2.5 per cent to overall constant-currency revenue growth of five per cent, with the rest coming from organic business.

Strong revenue performance could not translate into healthy profit due to one-off expenses including restructuring costs of $13 million. Adjusted for these, Tech Mahindra's operating profit margin grew a handsome 120 basis points sequentially to 16.1 per cent. One-off expenses, coupled with a sharp rise in tax rate (up 712 basis points to 30.8 per cent) and lower other income pulled down the net profit 14 per cent sequentially to Rs 645 crore. Fall in other income was due to a one-time spike in this metric in the base quarter of June 2016. Thus, the net profit came in lower than consensus Bloomberg estimate of Rs 702 crore. However, management believes this is one-off and expects net profit to stabilise over the next few quarters. It believes the tax rate will normalise to 24-25 per cent in FY17.

Going forward, the management believes growth in communications business (48 per cent of revenues) will continue. "I am feeling good about the core information technology part and digital part of our telecom business," C P Gurnani, chief executive, Tech Mahindra, said.

At current levels, the Tech Mahindra stock trades at an easy valuation of 11 times its one-year forward estimated net profit. While strong, sustained financial performance will improve sentiment, investors will also watch out for Brexit impact on the company. Tech Mahindra derives about 30 per cent of its revenues from Europe and is vulnerable to any unfavorable developments from Brexit. For now, the company remains optimistic on prospects. Its successful track record of inorganic growth is a key positive. While acquisitions such as LCC will lead to some volatility in operating profit margin in near term, management believes things will settle down in the next few quarters. Against this backdrop, most analysts are positive on the stock.