Motilal Oswal has maintained buy rating on the stock, with a target price of 490, implying an upside of 26 percent.
Tech Mahindra shares rallied as much as 7.4 percent Tuesday as analysts retained positive stance, expecting up to 31 percent upside in the stock after Q1 earnings beat expectations.
"The IT firm reported Q1FY18 revenues of USD 1.1 billion, up 0.6 percent QoQ, which was 2 percent above our estimates," Goldman Sachs said while reiterating buy rating on the stock.
Motilal Oswal said constant currency revenue declined around 2.1 percent QoQ, but was ahead of its estimate of a 3.4 percent decline, led by stabilisation of LCC revenues and above-estimate BFSI performance.
Including revenues from HCI (two months), constant currency revenue declined 0.6 percent, which was also ahead of its estimate of 2.2 percent decline, it added.
Goldman said the key driver of the positive surprise was an EBIT margin of 9.4 percent, up 120 basis points QoQ and 40/60bps above its estimates, as headwinds like forex, visa charges and more onsite presence during Q1 were offset by lower losses at subsidiary LCC and net headcount reduction.
The research house feels margins look set to improve further in Q2 given most of the headcount reduction happened towards the end of Q1, with benefits in employee costs/utilisation to emerge more in Q2.
Tech Mahindra saw a 4.1 percent QoQ reduction in software professionals headcount (3,407 employees) Utilisation at 77 percent including trainees was flat for the third quarter and down 100bp YoY, and remains a few points below management's target.
Profit in Q1 grew sharply by 36 percent sequentially to Rs 799 crore, driven by operational performance as well as other income. Revenue from operations declined 2.12 percent quarter-on-quarter to Rs 7,336.1 crore.
"Despite all headwinds in a seasonally weak quarter, digital business is growing ahead of our expectations backed by solid execution as we realign focus from Run side of the business opportunities to Change and Grow," CP Gurnani, MD & CEO said.
Digital deals are now 2.5 times the number Tech Mahindra was involved with in the same quarter last year.
Geography wise, Goldman believes European Union will be the key growth frontier for the company in near term with North America largely stable during Q1 despite headwinds.
Management on the earnings call was confident LCC restructuring is now behind with the number of deals under LCC now growing.
Since LCC’s acquisition in 2014, when it had an annual revenue run rate of USD 430 million, Tech Mahindra has been consistently restructuring this business, with a current annual run rate of USD 200 million
Tech Mahindra defended its growth in communications versus peers, highlighting that it has not lost any business to competitors, Motilal Oswal said.
What to do with the stock
Goldman Sachs increased its FY18-20 EPS estimates by 4/7/8 percent led by higher revenue/margin assumptions and lower depreciation & amortisation expense.
As a result 12-month target price raised to Rs 505 (from Rs 483 earlier), it said.
The research house has reiterated its buy rating given margin trajectory seems to be improving from current levels with the majority of LCC restructuring over and multiple margin levers like utilisation, offshoring and integration of recent acquisitions.
Increasing visibility on 5G capex globally would also drive telecom vertical growth, Goldman feels.
Motilal Oswal also increased its earnings estimates for FY18/19 by 9.5/1.6 percent. The significant FY18 upgrade comes on the back of combined effect from forex gains and revenue beat, it said.
The research house further said, "Tech Mahindra trades at 11.4x/10.6x FY18/19 earnings. There remains some tailwinds to improve profitability in the near term, which will feed positively into valuation multiple. Improvement in Communications revenue growth is an option value over and above the same."
Motilal Oswal has maintained buy rating on the stock, with a target price of 490, implying an upside of 26 percent.At 09:43 hours IST, the stock price was quoting at Rs 408.65, up Rs 23.40, or 6.07 percent on the BSE.Get access to India's fastest growing financial subscriptions service Moneycontrol Pro for as little as Rs 599 for first year. Use the code "GETPRO". Moneycontrol Pro offers you all the information you need for wealth creation including actionable investment ideas, independent research and insights & analysis For more information, check out the Moneycontrol website or mobile app.