Tech Mahindra: Margin recovery holds key

Firm sees short-term impact from Brexit ; Street will watch for a sustainable uptick in margins

Tech Mahindra delivered in-line results for the June  quarter (Q1) on all parameters but one. Though it met the Street expectations on revenues and earnings, margins were lower than the estimates. Its earnings before interest, taxes, depreciation and amortisation (Ebitda) margin came in at 14.9 per cent, visibly below the Bloomberg consensus estimate of 15.8 per cent. Higher visa costs and seasonal slowdown in Comviva (a company it acquired in 2012) weighed on margins. Adoption of Ind-AS accounting standards impacted margins by another 20 basis points in the quarter.

Will the company be able to regain the lost ground on margins? C P Gurnani, managing director and chief executive officer, is confident of margins catching up in the rest of the year. Analysts, though, have mixed views. This is because most of the acquisitions by Tech Mahindra in recent times have lower margins than the parent. As these companies aid revenue growth, they might have some bearing on the margins. The surprise element, though, can come in from rising digitisation and automation at the company. Digital revenues now form 20-22 per cent of the revenues. Despite the good show on revenues in the quarter, analysts could tone down their earnings estimates marginally to factor in the Q1 miss on margins.

Revenues in the quarter were helped by good growth in the enterprise segment. Though overall telecom revenues were under pressure, the traditional telecom segment grew well. It was the networking and value-added services segments that pulled down growth in this vertical. Management expects banking, financial services and insurance (BFSI) and health care to drive growth in FY17, even as aerospace and energy verticals are witnessing signs of uptick. Though, they believe, it is still early days to say the latter two have recovered on a sustainable basis.

Given its relatively higher exposure to Europe at 28 per cent, Tech Mahindra could witness higher volatility in revenues from this region in the near term. However, it believes the effects of this disruption should normalise in the long term. On the currency front, the management is confident and has a good hedging cover for the pound. While enterprise business is likely to drive revenues, the Brexit (UK decision to exit the European Union) impact could throw up some negative surprises.  In this backdrop, the stock might not witness a sharp run-up, despite un-demanding valuations of 13 times the FY17 estimated earnings.