Tech Mahindra Ltd shares have lost one-fifth of their value since the beginning of the current fiscal year compared with a loss of 1.5% for the S&P BSE IT index. The company’s December quarter financials will not lead to a reversal of that underperformance.
Revenue growth remains subdued. Sequential US dollar revenue growth slowed to 0.4% in the December quarter from 2.2% in the September quarter and 0.5% in the three months ended June. Even in constant currency terms, the revenue growth of 1.2% is slower than the 3% pace in the September quarter.
The telecom (or communications) business, which generates about half of Tech Mahindra’s revenues, remains a drag. The vertical’s contribution to revenue fell 1.6 percentage points from the September quarter number to 51.3%. According to the management, revenues fell owing to furloughs and project ramp-downs. As a result, contribution of revenues from its top 20 clients fell to 52%, down four percentage points from the previous quarter.
On the brighter side, the enterprise business continues to grow. Tech Mahindra continues to add clients and cost-cutting continues to deliver results. Cash flows improved significantly as receivable days, a measure of how quickly they get paid by customers, improved further to 104 days in the December quarter from 108 days in July-September.
Moreover, utilization levels improved to a record high of 80%. Due to a favourable base, selling and administration expenses saw a sequential drop of almost 7%. The quarter ended September saw higher expenditure due to transition costs of some large deals.
Lower expenditure helped the company expand margins 30 basis points to 16.9%. Still, net profit dropped 3.7% sequentially as the December quarter did not have the benefit of exceptionally high other income that the September quarter did. One basis point is 0.01%.
The management expects to cut more costs, which can help maintain or even improve margins. It also said the deal pipeline is stable. Tech Mahindra won around $1 billion worth of contracts so far this fiscal year—about a quarter of those were booked in October-December.
While that should provide comfort to investors, the ongoing transformations and consolidation in its telecom business vertical can weigh on overall growth. In a conference call with analysts, the management said client decision-making in the communications business vertical is very slow. Further it is overshadowed by constant budget controls.
Though the enterprise business is seeing good growth, the lack of clear signs of improvement in the company’s mainstay communications business will act as a drag on the stock even if valuations appear undemanding at 13 times one-year forward earnings.
The writer does not own shares in the above-mentioned companies.