Prabhudas Lilladher's report on Tech Mahindra
Tech Mahindra came out with an investor release highlighting the Q1FY16 and FY16 outlook. Management indicated marginal revenue decline with sustained pressure on margin in Q1FY16. However, outlook for FY16 for Enterprise Business continues to be optimistic. We continue to expect “Slow and Steady” improvement in the underlying business. We expect softness in near term, but retain our “BUY” rating as we continue to believe in their long-term structural growth outlook.
Q1FY16 – Weak revenue and margin outlook: Tech Mahindra expects marginal decline in revenue overall revenue due to drag from Communication business and seasonality in IP revenue. Moreover, full integration impact of LCC and SOFGEN, H-1B visa cost (100-125bp), and lower IP revenue would drag EBIDTA margin. We expected ~US$18m contribution from LCC and SOFGEN during the quarter. Nevertheless, we now expect ~0.5% QoQ decline in USD term revenue with margin erosion of ~60bp in Q1FY16.
Challenges in Communication business to persist; Enterprise a bright spot: In-line with the concerns highlighted in our note (dated 27th May), Management expects subdued organic growth for FY16 in Communications business due to delayed decision making. However, Enterprise business is expected to grow in-line or above Industry average. We expect ~11% YoY revenue growth in USD term in FY16. Moreover, we expect revenue momentum to pick-up in H2FY16.
Focus on Margin improvement: TechM’s EBITDA Margin was impacted due to multiple reasons 1) Integration of large acquisition like LCC and SOFGEN (both had high single digit margin) 2) Wage cost 3) Visa Cost 4) Lower IP revenue. However, we see some of these costs will get absorbed over the course of the year (FY16). Moreover, favourable currency movement, utilization improvement, and automation could provide tailwind for Margin in FY16. We expect margins to bottom out in H1FY16 and show improvement from thereon.
Outlook & Valuation – Retain “BUY” with a revised TP to Rs 640: "We expect earnings to bottom in Q2FY16. We revise our estimates down for FY16/17, and expect near term pressure on the stock price. Revised TP of Rs 640 (from Rs 710)", says Prabhudas Lilladher research report.
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