Tech Mahindra -2QFY11 – revenues meet, margins beat estimates. :: Kotak Sec

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Tech Mahindra (TECHM)
Technology
2QFY11 – revenues meet, margins beat estimates. Tech Mahindra (TM) reported a
handsome beat of our EBITDA and net income estimate for 2QFY11 despite a modest
revenue miss. Outperformance was driven by better-than-expected OPM (underlying
core margins 400 bps higher than estimate), aided by strong currency tailwinds and
sharp jump in utilization. We increase our EPS estimates for FY2011/12E by 3.3/3.8% to
Rs71.1/70.4, respectively. Raise target price to Rs760 (Rs735 earlier). Retain REDUCE.


2QFY11 – strong quarter, on balance
TM’s reported results for 2QFY11 were boosted by one-time pass-through revenue booking of
Rs3 bn (with an EBITDA margin of 5%). Adjusted revenues of US$265 mn (+5.4% qoq, +12%
yoy) fell 1% short of our estimate; however, adjusted EBITDA of Rs2.68 bn was 24% higher than
our estimate and net income of Rs1.74 bn beat our estimate by 15%. Adjusted OPM surprise (400
bps higher than expectation) was aided by (1) strong currency tailwinds – Re/USD as well as crosscurrencies,
and (2) sharp 600 bps jump in utilization to 75% as the company reported a net
headcount decline of 1,260 for the quarter. Volume growth was a reasonable 4.5% qoq.
Non-BT revenue momentum improving
We have been positive on non-BT revenue growth potential for TM. Our positive stance is on the
back of return of telco capex cycle across countries – this reflected in a strong 8.5% qoq growth in
US$ revenues from TM’s non-BT relationships in the Sep 2010 quarter and we expect the strength
to sustain in the coming quarters. Our confidence reflects in our above-Street revenue growth
estimate for TM – we build in a strong 18% US$ revenue growth for FY2012E, essentially
translating into a ~25% growth from non-BT accounts (assuming low single digit currency-led US$
revenue growth in the BT account). The company also announced a BPO deal win with Bharti
Africa – TM will take over assets and employees from the current set-up.
Margins likely to come under pressure ahead
We remain cautious on TM’s margin profile, however. Supply-side situation in the industry remains
challenging – TM with a high attrition rate of ~30% could face wage pressure ahead; also, Re
appreciation and impact of recent margin-dilutive deals (in our view) will likely add to the margin
pressure. We, accordingly build in 19% OPM for FY2012E, 270 bps lower than 2QFY11 levels.
Raise estimates to build in 2QFY11 outperformance and modest increase in OPM assumptions
We increase our FY2011/12E cons. EPS estimate for TM to Rs71.1/70.4 (up 3.3/3.8%) and raise our
SOTP target price to Rs760 (Rs735 earlier). Retain REDUCE on the stock noting the 3% valuation
downside. Stock is likely to trade on Satyam-TM merger ratio speculation in the near term.