Tech Mahindra defies IT gloom in Q3
Continuation of growth momentum and the margin trajectory will determine future direction for Tech Mahindra
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Tech Mahindra Ltd reported strong revenue growth for the second consecutive quarter. Revenue in US dollar terms increased 4.1% in the December quarter (Q3). In constant currency terms, it is up 5.4% from the September quarter (Q2). In comparison, HCL Technologies Ltd, which reported a strong performance, has seen its constant currency revenue rise 3% on a sequential basis.
As in the case of HCL Technologies, Tech Mahindra also benefited from inorganic growth initiatives. Even then, reported growth surpassed Street estimates. Kotak Institutional Equities, for instance, was expecting constant currency revenue growth of 3.8%.
The growth is led by BFSI (banking, financial services and insurance) and retail, transport and logistics verticals. Communications, which is still the single largest business vertical for Tech Mahindra, registered 1.7% sequential growth in revenue. In constant currency terms, the division is said to have grown by 3%.
Where the company did not impress or exceed expectations is profitability. Despite the favourable base—Q2 has seen one-time restructuring expenses—the Ebitda (earnings before interest, tax, depreciation and amortization) margin expanded just 80 basis points to 15.7%. According to an analyst with a domestic broking firm, adjusting for the Q2 restructuring expense, the margin would drop 40 basis points. But then, as the analyst clarifies, margins can see volatility on a quarterly basis as the company integrates recent acquisitions. A basis point is 0.01%.
Management commentary otherwise is encouraging. The management expects the enterprise business vertical to have outperformed the industry in the last quarter and it expects the momentum to continue. The company signed a large deal in the BFSI division and said its focus on a portfolio of services and geographical diversification is helping it overcome business volatility.
In a conference call with analysts, the management alluded to a recovery in the troubled communications business, citing a large order win. The number of active clients has risen to 837 from 825 in Q2 and 801 in the year-ago quarter. Client additions were highest in the $1-10 million contract category.
While the commentary should comfort investors who otherwise are worried about the overall slowdown in the IT (information technology) sector, profitability remains a weak link in Tech Mahindra. It is reducing costs through automation, which should aid profitability.
The savings, however, can be undermined by wage hikes (scheduled in the next quarter, though a decision is yet to be taken). Also clouding the margin outlook is the change in political regime in the US and fear that the country will raise visa costs for IT employees. Britain is yet to emerge out of the European Union, the incidence of which can raise business uncertainty, as it is another key market for Tech Mahindra.
While the issues affect the whole IT sector, the Tech Mahindra stock did relatively better than the BSE IT index in the last six months on growth recovery. Continuation of growth momentum and the margin trajectory will determine future direction of the stock.