A good chunk of Tech Mahindra' revenues comes from its telecom vertical, which is cyclical and cannot give strong growth every quarter, Madhu Babu of Centrum Broking told CNBC-TV18.
Tech Mahindra earlier today warned of lower profits for the first quarter (April-June).
Babu expects a 12-13 percent growth in mid-cap IT segment. “Over the last 5 years, the service mix in the segment has improved substantially, they have made good relationship with their top ten clients and had a good influx of senior management," he said.
Babu expects TCS to grow 4 percent in dollar terms and a bounce back from Infoysys, which reported a 2.75 percent revenue decline in the last quarter. For HCL Tech, he has a target of Ra 1060 per share and for Wipro, a target of Rs 660 per share.
Below is the transcript of Madhu Babu’s interview with Mangalam Maloo & Ekta Batra on CNBC-TV18.
Mangalam: Tech Mahindra has issued a profit warning today so your thoughts on that company and what ramifications it could have on the stock?
A: Tech Mahindra if you see last year the growth has been predominantly driven by few accounts in telecom. So, organic growth in telecom last year was very good around 20 percent. That was driven by KPN Base and AT&T accounts gaining good traction. Having said that, telecom is a cyclical vertical and Tech Mahindra derives almost 55 percent of revenues from this telecom vertical.
They have already being indicating that Q1 is going to be weak because these accounts are not going to replicate such kinds of high growth. So, last quarter if you see the 4 percent decline in dollar revenue growth, organically so this quarter again it is flat saying that it is a marginal decline. Weakness is going to flow into the stock.
Ekta: Midcap IT companies like KPIT and Persistent System issued profit warning last week and we have Tech Mahindra today. Would it worry you?
A: KPIT they have been facing some issues because of this cloud transition in some of its portfolio and even in Persistent, there is a client specific issue, which has led to that drag. We cannot replicate that as an overall sector midcap being hurt because of that.
Mangalam: Then in that case, do you expect midcap IT companies to deliver industry leading organic dollar revenue growth then?
A: Overall, there has been a transformational business in the midcap IT vendors. One is that over the last 5 years, the service mix has been substantially improved so lot of these companies have cross sell under penetrates services like Infrastructure management services etc. Secondly, they have made good relationship with their top ten clients. So, top ten clients have done a very good growth over last 4-5 years and thirdly, you have seen a good influx of senior management to the midcap IT companies.
Almost all the midcap IT companies have got some good leaders coming from the larger vendors like Infosys, Tata Consultancy Services (TCS) and all that. This stability of the performance has improved and so next year, even if you see leaving aside the Persistent warning most of the midcap IT companies, I am expecting them to do a 12-13 percent kind of organic growth. There is lot of comfort on the midsize IT companies like Mindtree, Hexaware and eClerx.
Ekta: Going into Q1 results now, what are the key trends that you would keep your eye on?
A: Q1 is supposed to be a seasonally strong quarter, so you have to look at the leader's growth. TCS and all should be doing around 4-4.5 percent kind of dollar term growth at least. That should be a key thing to look because that is the company which does well in the sector, so that at least gives the health of the demand environment. We are looking at bounce back from Infosys because last quarter has been very bad at around 2.7 percent decline in its revenues. Stability at Infosys is second big metric to watch.
HCL Tech, we are expecting a decent growth because again continued to be driven by IMS. Tech Mahindra, this weakness was there in last quarter also; it is flowing on to Q1. This year is going to be a weaker year for Tech Mahindra overall because last year has been very good. They had a 20 percent organic growth and with the overall sector, the slowdown in deal signings and all that and even the new deal which they have won, Comverse, that is going to flow in only from Q2.
Overall, Tech Mahindra might at max do a 5-5.5 percent kind of organic dollar term growth if you exclude the full impact of the Lightbridge acquisition, which is going to come. So, 5 percent organic growth compared to last year 14 percent; the stock has already seen a PE de-rating and after Monday's warning the de-rating can continue in the medium term.
Mangalam: What will your top picks in midcap IT stocks be?
A: HCL Tech is our top pick in the tier-I stocks, with target of Rs 1,060. There is a lot of margin of safety in Wipro, which is trading at 12.5 times FY17 earnings of around Rs 42. The risk-return is very favorable for Wipro and we have a target of around Rs 660.
Among midcaps, we prefer eClerx and Saint. eClerx we have target of Rs 1,740 and a buy rating because that is a niche company in the KPO segment and has a very good operating metrics in terms of margins, which are industry leading at around 33 percent, very good dividend payout ratio and a very good return on equities (RoE) of around 35 percent.
eClerx is a good preferred pick in a midcap with around Rs 1,740 target and Saint though it has run up, is a preferred pick in our midcap space currently. The other stocks we have a hold rating MindTree and Hexaware because of the rich valuations, which they are currently trading at.
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