Tech Mahindra - Q2FY14 Update - Rating changed to Accumulate, increased Target of Rs.1932 - Sushil Finance

Strong 4.7% USD Revenue growth led by 6.8% growth in Europe

The Q2FY14 Results of Tech Mahindra was much better than the expectations. During Q2FY14, its USD Revenues grew 4.7% QoQ to USD 758 mn, led by strong 6.8% growth in Europe & 5.5% growth in BFSI vertical. The organic growth in Revenue was 4.2% QoQ excluding contribution of Complex IT which contributed for 3 months in Q2 vs. 2 months in Q1. In constant currency term, its USD Revenue grew 4.5% QoQ. Support by currency benefits, its INR Revenues grew by 16.3% QoQ to Rs. 47,715 mn. During the quarter, the BFSI, TME and telecom vertical grew 5.5%, 3.8% and 2.7% QoQ respectively. Going forward, we expect Tech Mahindra to continue its strong growth momentum in Non-BT telecom accounts along with the decent growth in other verticals such as manufacturing, BFSI, TME and Retail.

EBITDA Margins up 220 bps QoQ on exchange rate benefits

Its EBITDA for Q2FY14 grew 28.5% QoQ to Rs. 11,110 mn, while the EBITDA margins expanded 220 bps QoQ to 23.3%, mainly on account of exchange rate benefit of ~3%, which was partially offset by 1% (-) impact of utilization. With sharp fall in other income (Rs. 380 mn v/s Rs. 2,073 mn in Q1) led by exchange loss of USD 4 mn, its PBT grew 7.6% QoQ to Rs. 10,027 mn and on account of higher tax provision (28.3% v/s 25% in Q1) its APAT grew 4.7% QoQ to Rs. 7,183 mn.

Considering the impact of net addition of 2170 people and wage increment (7% offshore, 2.5% onsite) effective Jan'14, we expect its EBITDA margins to remain at 21.6% in FY14 and to stabilize thereafter at 21% level.

Large Deal wins in Q2; Deal Pipeline looks decent

During Q2FY14, the company closed several large deals which include Application Maintenance and Development deal by the Volvo Car Corporation (Volvo Cars), five year managed service agreement with BASE company (a subsidiary of its large client KPN) for the operations & roll out of the BASE network in Belgium, and a large deal with US based insurance company. The TCV of all the deals signed during Q2 was close to ~USD 500 mn. The deal pipeline also looks decent as the company is currently chasing 5-6 large deals in both enterprise application and Telecom space.

Strong balance sheet with high Return ratio

The balance sheet of combined entity is very strong with high net cash & cash equivalent of USD 470 mn as on Sept'13. The return ratios have also improved significantly with strong RoCE (33.5%) & RoE (35.5%) for FY13. We expect the company to maintain its return ratios at these levels going forward. The company has already reached the annual business run-rate of USD 3 bn and it can utilize the higher cash in the balance sheet for M&A activities in order to achieve its vision of reaching USD 5 bn Revenues in next two years.

OUTLOOK & VALUATION

With ~25% CAGR in last six year in Non-BT accounts, compensating for decline in BT account, Tech Mahindra expects its Non-BT accounts to deliver decent growth, while BT's revenue is expected to be muted in short-term due to its internal rationalization program and stabilize going forward. The synergy from merger of Mahindra Satyam has further strengthen its market positioning as its expertise in enterprise solution space along with Tech Mahindra expertise in managed services is helping it in exploring new businesses opportunities across the markets and verticals.

In view of its strong H1FY14 performance & business outlook, we have upgraded our FY14E & FY15E Revenues & APAT estimates. We expect Tech Mahindra to deliver 23.7% CAGR in Revenue and 24.6% CAGR in APAT during FY13-15E. At CMP of Rs.1675, the stock is trading at 13.8x & 12.1x its FY14E & FY15E Earnings of Rs.121.7 & Rs.138 respectively. We have valued the stock at 14x its FY15E EPS and change our Rating to 'Accumulate' with an increased target price of Rs.1932.

Source : Equity Bulls

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