Tech Mahindra Ltd reported weak earnings for the June quarter, with operating profit declining 6.7% from the preceding quarter. Volume growth continued to be sluggish at 2%, against the March quarter, with revenue from BT Plc, its top client, remaining flat last quarter. Operating margin fell by more than 180 basis points because of a drop in employee utilization and an increase in the proportion of lower margin business process outsourcing (BPO) work. One basis point is one-hundredth of a percentage point.
BPO revenue grew 21% sequentially, thanks to revenue booked in Bharti Airtel Ltd’s African business. This business is expected to grow faster than the IT services business, what with its deal with Vodafone Hutchison Australia likely to ramp up the next quarter.
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As such, the overall margins of the firm may continue to drift lower. Also, note that the impact of this year’s salary increases will be felt only in the September quarter, since the wage hikes are effective 1 July. In the June quarter, margins were also impacted because of a drop in employee utilization rates, due to large-scale hiring in the BPO business.
Margins aren’t the only worry for investors. The firm said in a post-earnings call that BT, which accounts for 40% of its revenue, will re-tender its business for all its vendors. While the outcome of this process is uncertain, it’s likely Tech Mahindra will either lose out to more competitive vendors, or gain volumes at the cost of margins. According to a report by Tata Securities Ltd, “The company also indicated that because of this, its earlier guidance of £70-72 million (Rs 517-532 crore today) quarterly revenue from BT may not materialize.”
The company has been struggling with the BT account for some time now, and this is just the latest in a series of setbacks. While it’s heartening to note that the firm’s its non-BT clients are growing at a decent pace, the fact that BT still accounts for 40% of revenue exposes it to undue risks.
The silver lining is that the Satyam acquisition seems to be beginning to bear fruit. Last quarter, its share of Satyam’s profits was Rs 96 crore, more than half of its own profit of Rs 180 crore. This is one of the reasons Tech Mahindra shares haven’t declined much, post earnings. The positive earnings surprise in its associate firm has offset the disappointment in its own business.
Graphic by Ahmed Raza Khan/Mint