Markets
No turnaround in sight for Tech Mahindra
Summary
External demand headwinds continued to mar its earnings performance with revenue falling for the second quarter in a row.
Tech Mahindra Ltd’s investors have to sit tight; maybe tighter than those betting on other top large-cap technology stocks.External demand headwinds continued to mar its earnings performance with revenue falling for the second quarter in a row.
In the September quarter (Q2FY24), sequential constant currency revenues declined 2.4%, witnessing a sharper-than-anticipated fall primarily due to the ongoing slowdown in its key communications, media and entertainment vertical. The pain in this segment could persist, especially with respect to 5G, as clients are pulling back investments, the management said.
The company also initiated a business rationalisation exercise in Q2 which led to project closures with some of its non-core clients. These one-offs accelerated the adverse impact on revenue and earnings before interest and tax (Ebit) margin. The management commentary for H2FY24 is bleak.
Amid this, Tech Mahindra’s chief executive officer designate Mohit Joshi has announced a plan to simplify and streamline the organizational structure to foster deeper client relationships.
The ultimate goal is to boost revenue growth and margin via client mining and synergy benefits. Under Joshi’s plan, the company’s overall business has been consolidated to six strategic units. Americas will split into three units. EMEA (Europe, Middle East and Africa) and APJ (Asia Pacific and Japan) will be separate units. India will be the sixth unit. These changes will be effective from 1 January 2024. Since these are large structural changes, the management will be first testing them internally and is expected to share a detailed business plan and growth strategy with investors in April 2024. Investors are edgy. On Thursday, the stock fell2.3%, versus 1% decline in the Nifty IT index. The nervousness among investors is understandable. Restructuring efforts may reap benefits in the long run, but given the tepid IT demand globally and weak deal conversions, Tech Mahindra’s prospects of earnings revival versus peers could get delayed. A worry is that upfront costs involved in implementing these measures could dent near-term financials, which in any case are unimpressive. Further, according to ICICI Securities Ltd, Tech Mahindra still has very high reliance on the communication vertical and that may prove to be the Achilles heel of Joshi’s turnaround efforts. Among other challenges, the company could see exits at the management level, which tend to happen when such strategic changes are implemented. Of course, a lot depends on the pace of execution. On the bright side, while deal wins were still lower year-on-year in Q2FY24, they improved sequentially. Attrition eased to 11% and was the lowest among peers. Plus, subcontracting costs are reduced. Tech Mahindra did not provide any margin guidance, but the management believes there are levers to aid its margin profile. In any case, margins are unlikely to improve before FY25. The sharp cut in earnings estimates for FY24/FY25 by analysts suggests that as things stand, negatives have outweighed positives.
The path to a meaningful turnaround may be bumpy as the company may have to juggle between improving revenue growth and margin. “FY2024E will be a wash-out year for Tech Mahindra. FY2025E brings hope but has a fair set of challenges too," said a Kotak Institutional Equities report dated 25 October. The Street expects margin expansion together with growth acceleration, which appears unrealistic, it added. Valuations, too, reflect the Street’s subdued confidence. At FY25 PE, the Tech Mahindra stock is trading at multiple of 18x, showed Bloomberg data. This is a discount to most other tier-1 competitors.
