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Tech Mahindra's 2QFY11 operating performance was above estimates with EBITDA (excluding pass-throughs) at 21.7%
up 290bp QoQ (against our estimate of a 10bp increase to 18.9%). Rupee revenues (excluding pass-throughs) were
marginally above estimates at Rs12.35b, up 8.9% QoQ (against our estimate of Rs12.2b). Key highlights are:
EBITDA margins were up 290bp QoQ at 21.7% (against our estimate of 10bp QoQ increase) despite an 11% offshore
wage hike, which was a positive surprise. It was driven by: (1) a 600bp increase in utilization to 75% (against our
estimate of 300bp QoQ, an increase of 72%); (2) a 200bp impact of cross currency (appreciation of the GBP v/s the
US dollar), and (3) an 80bp QoQ reduction in SGA to 14.7% (against our estimate of 50bp QoQ reduction to 15%).
9.5% QoQ volume growth in non-BT volumes a key positive. BT revenues were stable at US$115m (up 1.7% QoQ on
the GBP appreciation). Overall rupee revenues grew 8.9% QoQ excluding pass-throughs (against our estimate of 8%
QoQ) due to (i) 4.5% QoQ growth in volumes, and (ii) ~4.5% impact of cross currency movements.
Quarterly annualized attrition rate of 30% in 2QFY11 is a key concern. It resulted in a net decline of 1,260 in the
employee count despite a healthy demand environment and hiring activity.
Sustaining healthy 2QFY11margin performance appears challenging due to: (1) high attrition rates, (2) currency
headwinds and (3) the impact of an onshore wage hike, due to set in from the next quarter.
Our estimates are largely unchanged after the results, as we see continued attrition and currency volatility as key risks
to sustenance of operating out-performance in the current quarter. We maintain Neutral on the stock, with a target price
of Rs736, based on 12x FY12E earnings.
Result highlights
US dollar revenue (excluding US$63.5m pass-throughs) increased 5.4% QoQ to
US$264.7m (against our estimate of a 7.1% QoQ increase to US$269m).
Rupee revenue (excluding Rs3b pass-throughs) was Rs12.35b, up 8.9% (against our
estimate of Rs12.2b, up 8% QoQ).
Reported BT revenue was US$115m (up marginally by 1.7% QoQ), mainly due to
GBP appreciation against the US dollar.
Reported EBITDA margins improved 290bp to 21.7% (against our estimate of 10bp
improvement to 18.9%) due to a 600bp uptick in utilization (against our estimate of a
300bp increase), reduced SGA (14.7%, against our estimate of 15%) and currency
impact.
Other income was Rs83m (against our estimate of Rs123m).
The effective tax rate was higher at 19.5% (against our estimate of 17%).
PAT (excluding pass-throughs and before prior period items and restructuring charges)
was Rs1.7b, up 19.2% QoQ (against our estimate of 1.5b); and PAT, including passthroughs
and before prior period items and restructuring charges, was Rs1.9b.
Adjusted PAT (after restructuring charges and excluding the impact of pass-throughs,
prior period items) was Rs1.4b (against our estimate of Rs1.1b), up 27.6% QoQ.
Headcount declined by 1,260 people to 34,007.
EBITDA margins a positive surprise; non-BT revenue up 8.5% QoQ; high
attrition a key concern
Tech Mahindra's 2QFY11 EBITDA margin improved 290bp QoQ (against our estimate of
10bp, to 18.9%), despite an 11% hike that became effective in this quarter for offshore
employees (75% of the total workforce). This was driven by: (1) a 600bp increase in
utilization to 75% (against our estimate of a 300bp QoQ increase to 72%), (2) a 200bp
impact of cross currency (appreciation of GBP against the US dollar), and (3) an 80bp
QoQ reduction in SGA to 14.7% (against our estimate of 50bp QoQ reduction to 15%).
The company's non-employee operating expenses as a percentage of total revenue dropped
by 6% in two quarters, aiding EBITDA margins. These expenses include costs incurred
on sub-contracting, which appear unlikely to subside soon, given high attrition rates. This
suggests it may not be a sustainable operating lever.
Quarterly annualized attrition rate of 30% in 2QFY11 was a key negative, which resulted
in a net decline of 1,260 employees despite a healthy demand environment and ongoing
hiring activity. With utilization levels at the peak of the guided band, high attrition will make
it difficult to sustain the margin out-performance achieved in the current quarter.
Other highlights
Debtor days stayed at 96, flat QoQ.
Outstanding USD-INR hedges of US$670m at Rs47.5/US$ and GBP-USD hedges of
GBP260m at US$1.74/GBP.
Offshore contribution (excluding pass-throughs) were stable at 63%.
Added seven new clients during the quarter, one client with annual run-rate greater
than US$50m.
Outstanding debt Rs14.3b.
Lease finance receivables of over US$60m on the balance sheet to be recovered over
3.5 years.
Valuation and view
The stock trades at a P/E of 14.3 FY11E and 12.8x FY12E adjusted earnings.
We maintain a cautious view on the stock due to (1) slower than industry growth due
to a sluggish BT account (43% of revenue), (2) skew of growth towards lower margin
segments (domestic BPO and new mobile operators in emerging markets), (3) margin
headwinds on elevated attrition and currency volatility, and (4) uncertainty over
Mahindra Satyam's financials and legal liabilities.
We maintain Neutral on the stock, with a target price of Rs736, based on 12x FY12E
earnings.
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