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Tech Mahindra's 3QFY11 revenue growth of 1.6% (excluding pass-throughs in 2QFY11, against our estimate of 6.2%)
was below estimate and PAT was higher due to US$8m in forex gains. The company is faced with challenges of sluggish
recovery in the Telecom vertical and high attrition. Key highlights:
Revenue growth of 1.6% to US$269.8m (excluding 2QFY11 pass-throughs worth US$63.5m) was below our estimate
of 6.2% growth, with volumes staying sequentially flat. Revenues from the BT account were static for the third
consecutive quarter at 74m pounds.
Sluggish recovery of the Telecom vertical and missing discretionary spend impeded growth. The management outlook
that the recovery within the segment may not meaningfully materialize over the next two quarters suggests tepid
volumes in the near term. However growth may come from key clients like Airtel, were its subscriber base in Africa
to ramp up in line with the plans.
EBITDA margins declined 110bp QoQ after outperforming with a 230bp sequential increase in 2QFY11, largely driven
by 3% salary hikes onsite. Recovery of margins to FY10 levels (over 24%) will be challenging given: (1) high attrition
rates, which may necessitate out-of-turn wage hikes, (2) expectations of lower utilization as utilization in 3QFY11
was at the higher end of the targeted band, amid ~30% quarterly annualized attrition.
Given that pick-up in discretionary traction may be a few quarters away, growth in the near term is likely to come
from lower end business, which will be potentially margin dilutive for the company.
Downbeat performance on volumes, guidance of delay in telecom revival and unrelenting attrition pressures are expected
to weigh on the stock in the near term. Owing to the prevailing challenges going forward, we have revised our estimates
downwards. We expect Tech Mahindra to post revenue CAGR of 9% over FY11-13 (against 12.7% earlier). Including
profits from Mahindra Satyam, we expect EPS CAGR of 10% (against 18% earlier) over FY11-13. Neutral.
Result Highlights
US dollar revenue increased 1.6% QoQ to US$268.9m (against our estimate of a
6.2% QoQ increase to US$281m).
Rupee revenues of Rs12.1b were down 1.9% (against our estimate of Rs12.5b, up
1.3% QoQ).
Reported BT revenues of US$118m were up by 3% QoQ, mainly due to the appreciation
of the British pound.
Reported EBITDA margins declined 110bp to 20.6% (against our estimate of a 160bp
decline to 20.1%) due to a 3% onsite salary hike; partially offset by a 140bp sequential
improvement in utilization to 76.3%.
Other income was Rs521m (against our estimate of Rs153m), led by forex gains of
US$8m.
The effective tax rate was 14.8% (against our estimate of 17%).
PAT (after prior period items and excluding Mahindra Satyam profits) was Rs1.6b
(against our estimate of 1.3b), up 22.3% QoQ
Result reflects pressures on demand and supply
Tech Mahindra's volume was sequentially flat, and the management cited persisting
challenges in the Telecom vertical, as the key factor. With BT revenues static, growth for
Tech Mahindra is expected to emanate from non-BT accounts and in emerging geographies.
However, revenue from the systems integration business in emerging markets was down
9.7% sequentially, given its lumpy nature. Given a general consensus now that the vertical
is not expected to recover meaningfully soon, the impact on the company's top-line growth
will be more severe than at its peers.
A decline in EBITDA margins after outperformance in 2QFY11 (230bp sequential increase)
was on expected lines, largely driven by a 3% salary hike onsite. Quarterly annualized
attrition rate of 30% was a repeat of the last quarter, implying no improvement on the
supply side. We believe the recovery of margins to FY10 levels (over 24%) will be
challenging given: (1) high attrition rates, which may necessitate out-of-turn wage hikes
and (2) the expectation of lower utilization as utilization in 3QFY11 was at the higher end
of the targeted band, amid ~30% quarterly annualized attrition rate for the past two quarters.
Other highlights
Headcount increased by 201 people to 34,208;
Added two clients in 3QFY11, taking client count to 126;
Outstanding US dollar-rupee hedges of US$780m at Rs48.1/US$ and British pound-
US dollar hedges of 270m pounds at US$1.71/pound;
Offshore contribution stable at 63%;
Outstanding debt decreased to Rs13.5b, from Rs14.3b in 2QFY11;
Cash and cash equivalents increased to Rs5.2b from Rs2.3b in 2QFY11.
Valuation and view
Downbeat performance on volumes, guidance of delay in revival in the Telecom vertical
and attrition pressures are expected to weigh on the stock in the near term.
We expect challenges on the demand and supply side to continue, with little chances of a
turnaround in the Telecom space in the short term. Consequently we have revised our
estimates downwards. We expect Tech Mahindra to post revenue CAGR of 9% over
FY11-13 (against 12.7% earlier). Including profits from Mahindra Satyam, we expect an
EPS CAGR of 10% (v/s 18% earlier) over FY11-13.
We maintain a cautious view on the stock due to (1) slower than industry growth due to
sluggishness in the BT account (44% of revenue) and the Telecom vertical in general, (2)
growth skewed towards lower margin segments (domestic BPO and new mobile operators
in emerging markets), (3) margin headwinds on elevated attrition and (4) uncertainty over
a turnaround at Mahindra Satyam and its legal liabilities.
The stock trades at 12.7x FY12E and 10.6x FY13E earnings. Maintain Neutral, with a
price target of Rs714, based on 11x FY13E.
Company description
Tech Mahindra is one of India's largest software exporters
and serves telecom service providers, equipment
manufacturers, software vendors and systems integrators.
It employs over 34,000 people and its key clients include
British Telecom and AT&T.
Key investment arguments
Satyam's acquisition will help Tech Mahindra to
diversify its client base and industry focus.
Large deals like those of Bharti and a gradual revival
in the Telecom vertical will help volume growth.
Emerging market telco rollouts and domestic BPO deals
are expected to be key growth contributors.
Key investment risks
The company is dependent on a single vertical, Telecom,
and a single client, BT (44% of revenue). Growth is
skewed towards lower margin services like new telco
rollouts and domestic BPOs.
High attrition rates (30% quarterly annualized attrition
in 3QFY11).
Uncertainty regarding Satyam's financials and legal
liabilities.
Recent developments
Tech Mahindra's BPO operations in Ghana are set to
go live from 1 February 2011. The company will also
start operations in five other countries between March
and May.
The company added two clients in 3QFY11, taking the
number of its clients to 126.
Valuation and view
Valuations at 12.7 FY12E and 10.6x FY13E earnings.
Maintain Neutral with a target price of Rs714, based
on 11x FY13E.
Sector view
Indian offshoring has been vindicated with global clients
and service providers making India their base for ITenabled
solutions. Still, India has less than 5% of the
global IT markets. We are positive on the long-term
prospects of the sector.
A slowdown in the US economy, wage inflation and
sharper currency appreciation are key concerns.
We reckon frontline Indian IT companies will be better
placed to sail through near-term adversities. Niche IT/
ITeS services companies with strong business models
are likely to be better placed to face near-term
uncertainty
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Tech Mahindra's 3QFY11 revenue growth of 1.6% (excluding pass-throughs in 2QFY11, against our estimate of 6.2%)
was below estimate and PAT was higher due to US$8m in forex gains. The company is faced with challenges of sluggish
recovery in the Telecom vertical and high attrition. Key highlights:
Revenue growth of 1.6% to US$269.8m (excluding 2QFY11 pass-throughs worth US$63.5m) was below our estimate
of 6.2% growth, with volumes staying sequentially flat. Revenues from the BT account were static for the third
consecutive quarter at 74m pounds.
Sluggish recovery of the Telecom vertical and missing discretionary spend impeded growth. The management outlook
that the recovery within the segment may not meaningfully materialize over the next two quarters suggests tepid
volumes in the near term. However growth may come from key clients like Airtel, were its subscriber base in Africa
to ramp up in line with the plans.
EBITDA margins declined 110bp QoQ after outperforming with a 230bp sequential increase in 2QFY11, largely driven
by 3% salary hikes onsite. Recovery of margins to FY10 levels (over 24%) will be challenging given: (1) high attrition
rates, which may necessitate out-of-turn wage hikes, (2) expectations of lower utilization as utilization in 3QFY11
was at the higher end of the targeted band, amid ~30% quarterly annualized attrition.
Given that pick-up in discretionary traction may be a few quarters away, growth in the near term is likely to come
from lower end business, which will be potentially margin dilutive for the company.
Downbeat performance on volumes, guidance of delay in telecom revival and unrelenting attrition pressures are expected
to weigh on the stock in the near term. Owing to the prevailing challenges going forward, we have revised our estimates
downwards. We expect Tech Mahindra to post revenue CAGR of 9% over FY11-13 (against 12.7% earlier). Including
profits from Mahindra Satyam, we expect EPS CAGR of 10% (against 18% earlier) over FY11-13. Neutral.
Result Highlights
US dollar revenue increased 1.6% QoQ to US$268.9m (against our estimate of a
6.2% QoQ increase to US$281m).
Rupee revenues of Rs12.1b were down 1.9% (against our estimate of Rs12.5b, up
1.3% QoQ).
Reported BT revenues of US$118m were up by 3% QoQ, mainly due to the appreciation
of the British pound.
Reported EBITDA margins declined 110bp to 20.6% (against our estimate of a 160bp
decline to 20.1%) due to a 3% onsite salary hike; partially offset by a 140bp sequential
improvement in utilization to 76.3%.
Other income was Rs521m (against our estimate of Rs153m), led by forex gains of
US$8m.
The effective tax rate was 14.8% (against our estimate of 17%).
PAT (after prior period items and excluding Mahindra Satyam profits) was Rs1.6b
(against our estimate of 1.3b), up 22.3% QoQ
Result reflects pressures on demand and supply
Tech Mahindra's volume was sequentially flat, and the management cited persisting
challenges in the Telecom vertical, as the key factor. With BT revenues static, growth for
Tech Mahindra is expected to emanate from non-BT accounts and in emerging geographies.
However, revenue from the systems integration business in emerging markets was down
9.7% sequentially, given its lumpy nature. Given a general consensus now that the vertical
is not expected to recover meaningfully soon, the impact on the company's top-line growth
will be more severe than at its peers.
A decline in EBITDA margins after outperformance in 2QFY11 (230bp sequential increase)
was on expected lines, largely driven by a 3% salary hike onsite. Quarterly annualized
attrition rate of 30% was a repeat of the last quarter, implying no improvement on the
supply side. We believe the recovery of margins to FY10 levels (over 24%) will be
challenging given: (1) high attrition rates, which may necessitate out-of-turn wage hikes
and (2) the expectation of lower utilization as utilization in 3QFY11 was at the higher end
of the targeted band, amid ~30% quarterly annualized attrition rate for the past two quarters.
Other highlights
Headcount increased by 201 people to 34,208;
Added two clients in 3QFY11, taking client count to 126;
Outstanding US dollar-rupee hedges of US$780m at Rs48.1/US$ and British pound-
US dollar hedges of 270m pounds at US$1.71/pound;
Offshore contribution stable at 63%;
Outstanding debt decreased to Rs13.5b, from Rs14.3b in 2QFY11;
Cash and cash equivalents increased to Rs5.2b from Rs2.3b in 2QFY11.
Valuation and view
Downbeat performance on volumes, guidance of delay in revival in the Telecom vertical
and attrition pressures are expected to weigh on the stock in the near term.
We expect challenges on the demand and supply side to continue, with little chances of a
turnaround in the Telecom space in the short term. Consequently we have revised our
estimates downwards. We expect Tech Mahindra to post revenue CAGR of 9% over
FY11-13 (against 12.7% earlier). Including profits from Mahindra Satyam, we expect an
EPS CAGR of 10% (v/s 18% earlier) over FY11-13.
We maintain a cautious view on the stock due to (1) slower than industry growth due to
sluggishness in the BT account (44% of revenue) and the Telecom vertical in general, (2)
growth skewed towards lower margin segments (domestic BPO and new mobile operators
in emerging markets), (3) margin headwinds on elevated attrition and (4) uncertainty over
a turnaround at Mahindra Satyam and its legal liabilities.
The stock trades at 12.7x FY12E and 10.6x FY13E earnings. Maintain Neutral, with a
price target of Rs714, based on 11x FY13E.
Company description
Tech Mahindra is one of India's largest software exporters
and serves telecom service providers, equipment
manufacturers, software vendors and systems integrators.
It employs over 34,000 people and its key clients include
British Telecom and AT&T.
Key investment arguments
Satyam's acquisition will help Tech Mahindra to
diversify its client base and industry focus.
Large deals like those of Bharti and a gradual revival
in the Telecom vertical will help volume growth.
Emerging market telco rollouts and domestic BPO deals
are expected to be key growth contributors.
Key investment risks
The company is dependent on a single vertical, Telecom,
and a single client, BT (44% of revenue). Growth is
skewed towards lower margin services like new telco
rollouts and domestic BPOs.
High attrition rates (30% quarterly annualized attrition
in 3QFY11).
Uncertainty regarding Satyam's financials and legal
liabilities.
Recent developments
Tech Mahindra's BPO operations in Ghana are set to
go live from 1 February 2011. The company will also
start operations in five other countries between March
and May.
The company added two clients in 3QFY11, taking the
number of its clients to 126.
Valuation and view
Valuations at 12.7 FY12E and 10.6x FY13E earnings.
Maintain Neutral with a target price of Rs714, based
on 11x FY13E.
Sector view
Indian offshoring has been vindicated with global clients
and service providers making India their base for ITenabled
solutions. Still, India has less than 5% of the
global IT markets. We are positive on the long-term
prospects of the sector.
A slowdown in the US economy, wage inflation and
sharper currency appreciation are key concerns.
We reckon frontline Indian IT companies will be better
placed to sail through near-term adversities. Niche IT/
ITeS services companies with strong business models
are likely to be better placed to face near-term
uncertainty
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