Tech Mahindra - Better margins, acquisition-led growth in Q2; maintain Add - BRICS

TECHM reported in-line revenue, up 6.4% qoq to $299m, driven by acquisition (Hutchinson Global Services - HGS, which contributed US$13.4mn) and a growth of 4.8% qoq in non-BT clients. BT account remained weak (down 3.8% qoq), which is likely to continue for a few more quarters due to restructuring. We maintain P/E multiple of 12x and raise our target price to Rs970 (from Rs840), as we rollover to FY14 estimates. Maintain ADD.

Operating and net earnings beat expectations: Revenue grew 5.7% qoq to Rs16.3bn, driven by acquisition (HGS consolidated for one month). Comviva integration is pending, as regulatory approvals are awaited. Non-BT accounts were up 4.8% qoq and the strong growth should sustain, as two large deals (KPN and large managed services deal from UK based client) are likely to ramp up from Q4FY13. Despite the impact of wage hike (6% offshore & 2% onsite) and consolidation of the lower margin HGS business, the decline in EBITDA margin was limited to 70bps (to 20.7%), as benefits from focus on lower margin projects and cost optimization flowed in. Earnings surpassed estimate, as tax refund of overseas operations resulted in lower tax expenses.

Demand pipeline stable, closure rate sluggish: Management has indicated that decision making by clients remains slow, resulting in delays in deal closures. It has not witnessed any pricing pressure and competition remains stable. Deals are mostly taking place in the managed services space for cost reduction and vendor consolidation.

Valuation: Stock trades at 14.9x FY13 and 12.4x FY14 our core earnings estimates. In view of the better than expected margin improvement, due to cost optimization measures (SG&A savings, utilization and employee pyramid), we have raised our FY13/14 earnings estimates. The ramp up of two large deals by H1CY13 and strong growth in existing non-BT accounts could offset the continued weakness in BT. The acquisitions (HGS and Comviva) will be margin dilutive, but EPS accretive. We raise our target price to Rs970 (12xFY14 core earnings and Rs45/share for 42.3% holding in Satyam). Maintain ADD.

Raising earnings estimates: We have raised our earnings estimates in line with the change in our exchange rate assumption to Rs53/US$ (from Rs55/US$ earlier) and marginally increased our estimated margins for FY13/14 to account for the continued benefits from cost optimization measures, such as manpower reduction, right sizing employee pyramid, utilization improvement, etc. We have not yet included Comviva's financials, which is likely to be margin dilutive.

Source : Equity Bulls

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