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Home >Markets >Mark To Market >Tech Mahindra had a great Q1; Is it time for a stock re-rating?

IT services provider Tech Mahindra Ltd has exceeded the Street’s earnings expectations in a seasonally weak quarter. Its constant currency revenue growth of 3.9% on a sequential basis was ahead of consensus estimates of 2.3% growth. It has also outperformed some of its peers such as Tata Consultancy Services Ltd and HCL Technologies Ltd on this parameter.

Revenues got a boost from broad-based growth across verticals with a healthy recovery in manufacturing and technology. Geographically, growth was strong in the Americas and Europe, while revenue from the rest of the world contracted sequentially on a high base of the previous quarter.

An impressive show
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An impressive show

Tech Mahindra won net new deals worth $815 million versus $1,043 million in the previous quarter. Net new deal wins declined sequentially, but were well split between enterprise and communications, the management said in a post-earnings conference call. Deal wins were aided by a large deal in the healthcare vertical and a large deal in the business process outsourcing space in the communications vertical, the management said. The number of active clients also grew by 51 in Q1FY22 compared to the previous quarter.

Tech Mahindra is seeing good traction in digital transformation among clients and its 5G deal pipeline continues to be strong, the company said.

The management refrained from sharing revenue growth guidance, but said that a strong deal pipeline gives it the confidence to maintain the current trajectory of revenue growth.

The company’s earnings before interest and taxes (Ebit) margin at 15.2% fell 130 basis points (bps) sequentially, but profitability was higher than the consensus estimate of 14.5%. One basis point is one-hundredth of a percentage point. Despite hikes in wages and visa-related costs, margins got a cushion from lower selling, general and administrative costs, higher utilization levels and higher offshore revenue mix. The company reiterated it aims to maintain operating margins around 15%.

The company’s impressive Q1 earnings bode well for its valuations, which are significantly lower than peers, analysts said. “Tech Mahindra’s one-year forward price-to-earnings multiple of 17 times is a 50% discount to larger competitors. In FY22, we expect the company to report margins higher than the 15% guidance shared earlier. A sharp rebound in margins and double-digit topline growth because of an improvement in global 5G roll-out and higher demand for enterprise technology makes a case for valuation re-rating," said Suyog Kulkarni, senior research analyst at Reliance Securities Ltd.

That said, attrition remains an industry-wide issue and is seen as a potential threat to margins. Tech Mahindra’s attrition has jumped by 400bps on a sequential basis to 17% in Q1. The management said it expects attrition levels to be a bit higher given the demand environment. Thus, talent acquisition would be among the focus areas in FY22. The firm aims to hire globally across its offices for verticals such as artificial intelligence and Internet of Things. In India, hiring is likely to be higher in tier-2 cities. The management said that headcount increased by 5,209 in the June quarter and it aims to hire three times more freshers in FY22 than it has in the past.

Shares of the company were trading higher ahead of its Q1 earnings announcement on Thursday. Analysts expect the stock to react positively to the Q1 earnings on Friday given the wide beat. Currently at 1,127, the stock is 34% higher than its pre-covid high.

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