Tech Mahindra - Can margins surprise further? - ICICI Securities

The key rationale behind our BUY rating for Tech Mahindra (TechM) was the potential surprise on the pace of margin expansion (refer our note - Pace of margin expansion may surprise). In-line with our thesis, EBITDA margin expansion of ~390bps QoQ came in significantly ahead of consensus estimates. It was also broad based with both IT services (+290bps QoQ) and BPO (+15 pp QoQ) reporting healthy expansion. Easing of supply bottlenecks aided the sharp bounce back in margins/revenue of BPO. BPO margins were significantly ahead of pre-Covid level (+760bps, vs CY19) indicating some mix rationalisation effort underway. Margins should expand further led by more tailwinds from (1) headcount reduction in IT services and (2) mix rationalisation. Skewed growth - due to RoW across geographies and BPO across services - was the key negative in the result. Accounting for supply normalisation, demand in key geographies looks sequentially deteriorated. Even as we anticipate TechM to lag peers on revenue growth over FY20-23E (CAGR: 3.9%), we remain buyers given the (1) headroom for margin expansion and (2) undemanding valuations (14.3 FY22E EPS).

- Weak quality revenue growth; strong margin beat. Revenue growth (+2.9% QoQ, CC) was 170bps ahead of our estimates. However, the quality of comeback was weak on two counts - (1) RoW across geographies (+11.7% QoQ, US$) and (2) BPO across service lines. Across verticals, while communication remained largely flat, growth was almost entirely led by enterprise (+4.3% QoQ, CC). Barring manufacturing, other sub-verticals within enterprise reported strong sequential comeback.

EBIT margins were ~230bps ahead of street estimates. While IT services lagged on growth, headcount reduction (2.1% QoQ in delivery and 8.2% in sales & support) and consequent improvement in utilisation ensured big contribution to overall margin expansion. Aided by easing of supply bottlenecks, BPO margins witnessed a dramatic rise (+15 pp QoQ) and are now above pre-Covid levels (+760bps, vs CY19).

- Should underperform on revenue growth; bet on further margin expansion. For the reasons elaborated in our recent note (link), we foresee further delays in 5G spending. Besides, softness in manufacturing (~16% of revenue) should translate into continued revenue growth underperformance vs large-cap peers (TCS, Infosys, HCLT) over FY20-FY23E. Sharp reduction in sales & support headcount (-8.2% QoQ) also seem to be indicative of the limited demand visibility. However, while sustainability of current margins is a key point of debate, we are confident margins should expand led by further tailwinds from - (1) headcount reduction in IT services and (2) mix rationalisation. This headroom for margin expansion and undemanding valuations underpin our BUY rating.

Shares of TECH MAHINDRA LTD. was last trading in BSE at Rs.848.1 as compared to the previous close of Rs. 838.1. The total number of shares traded during the day was 215562 in over 4809 trades.

The stock hit an intraday high of Rs. 857 and intraday low of 833.4. The net turnover during the day was Rs. 182466780.

Source : Equity Bulls

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