What is ailing Tech Mahindra despite a decent March quarter?

This despite the company reporting a 39.2 percent growth in profit after tax (PAT) at Rs 1,506 crore from Rs 1,081 crore during the corresponding quarter of the previous year.

The Mahindra group company registered a year-on-year growth of 24.5 percent in its revenue at Rs 12,116 crore.

The ongoing correction in IT stocks has had an impact on valuations that have become much more reasonable, though some experts still think they are high.

“The global IT sector has been under pressure due to the highly uncertain economic scenario and increasing attrition rate and Nasdaq, widely known as a tech-heavy index, is down by (26 percent) in 2022”, said Sunil Damania, chief investment officer, MarketsMojo.

Due to the fall in Nasdaq, Indian IT companies, too, have been under pressure.

Home truths

Tech Mahindra has lost 37 percent during the first five months of 2022 and has declined close to 11 percent in the past month.

Why is the stock not performing well? Experts say there are several factors at play apart from the overall market and sector-specific sentiment.

Experts were expecting a strong commentary and margin guidance from the company but it didn’t happen. The weak commentary by the management did not help investor confidence, they said.

“The Q4 EBIT (earnings before interest and tax) margins contracted by 159 bps q-o-q to 13.2 percent, which was below our and street’s estimates as well, owing to rising expenses to backfill higher attrition, salary and retention related impact, lower utilization and 80 bps increase in depreciation due to higher M&A activities,” said Aashish Dash, Research Analyst at Sharekhan by BNP Paribas.

He said the amortisation cost will continue to be high in the coming quarter due to the recent acquisitions made by Tech M.

The company’s attrition rate surged to 23.5 percent in Q4FY22 from 13 percent in Q4 FY21.

“Higher attrition coupled with increasing salary costs is expected to pressure the company’s margins in the quarters ahead,” Damania said.

Weak quarters ahead?

The April-June period is typically a weak quarter for the company due to which experts don’t expect a significant improvement in the performance.

“The company undertakes wage hikes in the second quarter (effective from July) of the financial year, which is likely to limit the margin improvement in the second quarter,” Dash said.

“The other factors weighing on the stock performance are its low cash conversion and the likely increase of close to 150 bps in its effective tax rate from 24.5 percent currently to around 26 percent for FY23 which could further impact the bottom line”.

Tech M generated a quarterly free cash flow (FCF) of $111 million which was down 10 percent from the previous quarter.

“FCF to PAT conversion ratio stood at 59 percent compared to 67 percent during the previous quarter of the current financial year,” said Dash.

Its cash & cash equivalents declined to $1,141 million during the quarter compared to $1,346 million in Q3FY22, due to the acquisitions made by it.

Despite growing revenue, the company’s operating margins stood at 17.24, the lowest in the last five quarters. Lower margins and increasing costs don’t paint a promising picture.

“Looking at the industry outlook, we perceive falling margins with high attrition rates are unlikely to ease until the September quarter,” said Damania.

He does not recommend fresh buying in this stock but said those who have invested in it, to hold on to the stock.

At 3.05 pm, the stock was trading at Rs 1,122 on the National Stock Exchange, up 4.11 percent from the previous day's close.

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