Tech Mahindra’s Q4 results underscore why it’s been an unexciting bet for investors

  • After an exceptionally strong show in Q3, Tech Mahindra’s growth fell off the cliff in Q4
  • Worse still, profit margins fell at a higher-than-expected rate, underscoring cost pressures

After an exceptionally strong performance in the December quarter, things were expected to cool down at Tech Mahindra Ltd. But as it turns out, growth fell off the cliff in the March quarter. Dollar revenues grew just 0.5% on a sequential basis, notably lower than the Street’s estimates. Worse still, profit margins narrowed at a higher-than-expected rate, underscoring cost pressures.

It’s interesting to note that the company’s revenue growth has moderated at a time when its largest business vertical, communications, returned to the growth mode. Revenue at the division, which generates about 41% of overall sales, grew 4.4% on a sequential basis. Growth stood at 4.6% on a year-on-year basis, up from 0.1% in the December quarter. Company-wide growth, on the other hand, slowed to merely 1.9% in the March quarter year-on-year, down from 4.3% in the December quarter.

Evidently, other business segments are performing poorly. Revenue in the enterprise business segment dropped 2.2% on a sequential basis. According to the management, closure and deferment of some projects weighed on revenue in the enterprise business.

The disappointment does not end there. A notable rise in sales and general administration expenses resulted in profit margins moderating by 70 basis points, snapping a long streak of improvement on this front (see chart).

The performance will displease investors. But a 7% fall so far this month vis-à-vis the 5.6% drop in the Nifty IT index, and low valuations, mean the damage may be limited. Tech Mahindra is trading at about 12 times FY21 earnings estimates, a notable discount to tier-I IT firms.

On the positive side, the company continues to see strong order bookings. It signed contracts worth $408 million last quarter. This comes on the back of $440 million in deal wins in the December quarter and $550 million in the three months ended September.

The strong deal wins should help the company deliver good growth in FY20, said the management. “We are encouraged by the revival of the communications business," C.P. Gurnani, managing director and chief executive officer, Tech Mahindra, said in a statement.

Though the enterprise business vertical lagged in the March quarter, the hope is that execution of the order book should help it maintain the growth momentum in FY20. Revenue in the non-communication vertical, which largely constitutes the enterprise business, grew 7.9% in FY19.

But as they say, there is many a slip between the cup and the lip. It remains to be seen if orders translate into revenues at a pace investors like. Further, high attrition and elevated expenses can weigh on profitability as well. The Tech Mahindra stock may be cheap, but the narrative around it isn’t compelling.