Tech Mahindra investors await next earnings trigger
Tech Mahindra still believes it has sufficient margin levels at work, such as automation, improvement in performance of subsidiaries and optimization of the onshore-offshore workforce mix
Tracking the recovery in profitability, shares of Tech Mahindra Ltd have gained a handsome 64% over the last year. The company continued the trend in the March quarter as well with earnings before interest and tax (Ebit) margins expanding both sequentially and compared to a year ago. (See chart).
Profitability was aided by a better business mix, improvement in utilization, seasonality in certain business segments and a favourable currency. But the key question to ask is: will the existing triggers be sufficient to drive stock performance?
The management still believes it has sufficient margin levers at work such as automation, improvement in performance of the subsidiary companies and optimization of the onshore-offshore workforce mix.
However, improvement in profitability from here on is expected to be rather gradual.
Margins in the current quarter will be weighed down by wage hikes and seasonal weakness at one of its subsidiary companies.
In the event of the near term headwinds and only gradual margin improvement, profitability alone cannot be the earnings driver for long. Revenue growth should accelerate. Unfortunately, the outlook on this front remains hazy.
The 1.7% sequential constant currency revenue growth in the March quarter was slightly ahead of Street estimates.
However segmental performances do not provide any signs of revenue acceleration in the near term. According to analysts, deal sizes remain small and growth in total contract value remains subdued.
The enterprise business continues to do well.
But the largest business vertical—communications—which generates 43% of Tech Mahindra’s revenues is either flat or seeing a revenue fall (on a year-on-year basis). According to the management, the company has given up some low yield business which impacted revenues.
Even so, the communications division still lacks structural growth drivers.
Transition to the fifth generation (5G) mobile technologies is expected to open new opportunities. But there is no clarity when the spending will kick in.
The management expects clarity on this to emerge in another year which means near term growth expectations remain more or less unchanged. “Given the fact that revenue growth was in line this quarter, and that expectation of trends in communication and enterprise remains unchanged, our revenue estimates remain where they were,” Motilal Oswal Securities Ltd said in a note.
True, estimates for margin have seen a slight upgrade.
But lack of revenue upgrades is a handicap for the stock that has rallied over the last year.
“We keep our revenue growth estimates intact but increase margin estimates slightly on good execution in FY18. However, the valuation is already capturing the growth prospects,” Emkay Global Financial Services Ltd said in a note.