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Tech Mahindra: Other income helps profits - Views on News from Equitymaster

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Tech Mahindra: Other income helps profits
Jan 23, 2008

Performance summary
  • Topline grows by 8% QoQ during 3QFY08, driven by TSP and BPO segments.
  • Operating margins stable at 22%. However, on a half-yearly basis, these have declined by almost 3%.

  • Bottomline expands by 10% QoQ during 3QFY08, largely due to higher other income (up 21% QoQ) and lower interest outgo.

  • Employee addition remains flat but utilisation increases by 6% QoQ.

Consolidated financial snapshot
(Rs m) 2QFY08 3QFY08 Change 9mFY07 9mFY08 Change
Sales 8,976 9,704 8.1% 20,538 27,443 33.6%
Expenditure 7,004 7,575 8.2% 15,403 21,409 39.0%
Operating profit (EBDIT) 1,972 2,129 8.0% 5,135 6,034 17.5%
Operating profit margin (%) 22.0% 21.9%   25.0% 22.0%  
Other income 249 300 20.5% (72) 680  
Interest 26 16 -40.0% 12 56 384.5%
Depreciation 193 206 6.5% 358 567 58.3%
Profit before tax 2,002 2,208 10.3% 4,693 6,092 29.8%
Tax 187 213 13.9% 537 582 8.5%
Minority interest (2) (1)   - (6)  
Extraordinary Items - -   339 -  
Profit after tax/(loss) 1,817 1,996 9.9% 4,495 5,515 22.7%
Net profit margin (%) 20.2% 20.6%   21.9% 20.1%  
No. of shares (m)       131 131  
Diluted earnings per share (Rs)*#         17  
P/E ratio (x)*#         42.6  
* On a trailing 12-months basis  # Adjusted for extraordinary items during 4QFY07

What has driven performance in 3QFY08?
  • Tech Mahindra recorded 8% QoQ growth in topline during 3QFY08. This was driven by growth in the TSP (Telecom Service Provider) as well as the BPO segments. While the TSP segment grew by 4% (66% of incremental revenues) the BPO recorded growth of 50% (25% of incremental revenues). The company derived 20%, 70% and 10% of its revenues in 3QFY08 from the US, Europe and ROW (Rest of the world) regions respectively. Revenue growth in these geographies was 14% QoQ, 1% QoQ and 80% QoQ respectively. The company added 9 clients during the quarter while the attrition rate stood at 22%.

    Segment-wise details (Standalone)
    Revenues (Rs m) 2QFY08 % share 3QFY08 % share Change
    Telecom Service Provider (TSP) 7,901 91.9% 8,245 90.4% 4.4%
    Telecom Equipment Manufacturer (TEM) 220 2.6% 300 3.3% 36.4%
    BPO Services 265 3.1% 398 4.4% 50.2%
    Others 207 2.4% 173 1.9% -16.4%
    Total 8,593   9,116   6.1%
    PBIT (Rs m) 2QFY08 PBIT margins 3QFY08 PBIT margins Change
    Telecom Service Provider 2,910 36.8% 3,024 36.7% 3.9%
    Telecom Equipment Manufacturer 34 15.5% 72 24.0% 111.8%
    BPO Services 84 31.7% 172 43.2% 104.8%
    Others 59 28.5% 55 31.8% -6.8%
    Total 3,087 35.9% 3,323 36.5% 7.6%

  • Tech Mahindra’s operating margins remained stable at 22% in 3QFY08. However, the real concern is the fall in operating margins on a nine-month comparison where the same have actually contracted by 3% due to rising staff costs and SG&A expenses. This decline has also prompted management to increase utilisation and hold on to the employee addition in the near term. While, in this quarter, the employee intake remained flat with the company adding just 55 new recruits, utilisation levels increased from 63% in 2QFY08 to touch 69%. This helped the company manage its profitability during the third quarter. The company has lowest utilisation in the industry among its peers and is now targeting levels of around 75%.

  • Tech Mahindra’s net profits grew by 10% QoQ during 3QFY08 mainly due to 21% QoQ increase in other income and lower interest outgo. The company took on some debt in its books in 4QFY07 for making one time payment to British Telecom (BT) for the US$ 1 bn deal. The debt has now been repaid and has thus resulted in lower interest outgo in 3QFY08. The company has a forex hedge of US$ 800 m at the end of 3QFY08.

What to expect?
At the current price of 732, the stock is trading at a multiple of 7.7 times our estimated FY10 earnings. With the global trends not looking very bright, the chances that the IT budgets in the telecom sector will be cut now appear much stronger. However, if it does happen, then offshoring as a percentage of total IT budgets will stand to gain but the appreciation in currency will offset the gain arising on increase in offshoring. So the challenges will be to maintain the margins and also at the same time increase the productivity. At these levels we are positive on the stock from a long-term perspective.

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