Information technology services provider Tech Mahindra Ltd reported a massive earnings surprise, with its net profit growing by 31% sequentially to Rs227 crore.
Analysts at Citigroup Inc., Motilal Oswal Securities Ltd and ICICI Securities Ltd had estimated a net profit of between Rs172 crore and Rs187.5 crore, and the reported profit is 25% higher than the median of their estimates.
Still, the markets are unlikely to be overly excited about the results, since the profit last quarter was boosted by some one-off factors. Other income rose from Rs0.6 crore in the December quarter to Rs74 crore last quarter thanks to unexpectedly high gains from hedging.
The company also reported a higher than expected operating profit of Rs278.8 crore. This is 11% higher than the median estimate of the three brokers mentioned above. But here, too, the company benefited from some one-off projects from its top client, UK telecom firm BT Group Plc.
Graphic: Ahmed Raza Khan/Mint
According to the company, it received some one-off projects due to the year-end effect and doesn’t expect these projects to continue. As a result, revenue from BT, which has been sluggish in recent quarters due to the turmoil at the company, grew by around 7% in constant currency terms. The company didn’t quantify the revenue earned from these projects.
Also, analysts were factoring in a margin decline of about 150 basis points owing to a sharp appreciation in the pound and the euro against the rupee. One basis point is one-hundredth of a percentage point. The company derives at least 55% of its revenues from the region and was expected to be hit severely. Instead, it reported flat margins. According to the company, it was able to offset the impact of rupee appreciation and higher selling, general and administration costs through a shift of work to offshore locations and an improvement in its business mix. But analysts don’t buy that argument entirely. According to an analyst, the one-off revenue from BT seem to have come at an unusually high profit margin as well.
Another surprise factor in the company’s results is that although its employee base has increased by a sharp 26% in the past two quarters, employee costs have been more or less flat in the two quarters. A number of analysts asked the company to explain the reason for this on its earnings call, but the company didn’t have a satisfactory response. The company’s chief financial officer said that one should not look at employee costs in isolation, but include travel costs and the remuneration paid to sub-contractors. But even after including these, employee related costs rose by just 1.4% last quarter, on the back of a mere 0.06% rise in the December quarter. And in any case, the employee number reported by the company doesn’t include sub-contractors, so it doesn’t make sense to include their remuneration cost for an apples-to-apples comparison.
The large increase in the company’s employee base in the past two quarters is difficult to understand for another reason as well. The company’s commentary on business outlook has been relatively weak and revenue from BT is expected to be flat at best.
In the December quarter, investors and analysts had been peeved with the company because of an inconsistent accounting policy. While the March quarter reporting isn’t as controversial, there are a few unanswered questions even after the company’s earnings call. This could affect the company’s valuations further, even after the massive de-rating following the December quarter results. Tech Mahindra shares have dropped by 32% since the third quarter results announcement, while the CNX IT has risen by 2% during the same period.
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