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Tech Mahindra: Lower provisions lift profits
Feb 4, 2014

Tech Mahindra has announced its third quarter results for the financial year 2013-2014 (3QFY14). The company reported a 2.7% QoQ (quarter on quarter) growth in consolidated sales and a 40.6% QoQ growth in net profits. Here is our analysis of the results. The financials include the combined data of erstwhile Tech Mahindra and Mahindra Satyam.

Performance summary
  • Consolidated net sales grew by 2.7% QoQ. In terms of US dollar, growth in revenues was 4.4% QoQ.
  • EBITDA (Earnings before interest, tax, depreciation and amortization) margin decreased marginally by 0.1% QoQ to 23.2% at the end of 3QFY14. A significant QoQ increase in the expenses related to associate companies impacted the operational performance. On an absolute basis, EBITDA grew by 2.3% QoQ.
  • The net profit grew by 40.6%QoQ. The company wrote back Rs 1200 m in provisions of previous years relating to the Satyam acquisition. Also the provision for taxation in this quarter was also significantly reduced due to this write back.
  • The company's employee base stood at 87,399 at the end of December 2013, recording a growth of 2.5% QoQ.
  • The total number of active clients increased from 576 at the end of 2QFY14 to 605 at the end of 3QFY14.

Consolidated Financial Snapshot
(Rs m) 2QFY14 3QFY14 Change 9MFY13 9MFY14 Change
Sales 47,715 48,985 2.7% 49,659 137,733 177.4%
Expenditure 36,604 37,622 2.8% 39,217 106,614 171.9%
Operating profit (EBITDA) 11,111 11,363 2.3% 10,442 31,119 198.0%
Operating Profit Margin (%) 23.3% 23.2%   21.0% 22.6%  
Other income 381 (457)   (512) 1,997  
Interest 242 236 -2.3% 731 701 -4.1%
Depreciation 1,222 1,396 14.2% 1,407 3,792 169.6%
Exceptional items - 1,200   - 1,200  
Profit before tax 10,028 10,474 4.4% 7,792 29,823 282.7%
Tax 2,840 264 -90.7% 1,644 5,430 230.3%
Minority interest 4 111   71 245 242.4%
Profit from assosiates - -   3,029 -  
Profit after tax/(loss) 7,184 10,099 40.6% 9,105 24,148 165.2%
Net profit margin (%) 15.1% 20.6%   18.3% 17.5%  
No of shares (m)         233.2  
Diluted earnings per shares         119.8  
P/E ratio#         15.3  
# On a trailing 12-months earnings basis

What has driven the performance in 3QFY14?
  • Tech Mahindra recorded a 2.7% QoQ growth in its net consolidated sales during the quarter. This was driven by broad based growth across verticals. The company witnessed a 2.7% QoQ growth in each of verticals of 'Telecom' (47% of total sales). 'Manufacturing' (19% of total sales), 'Retail, Transport and Logistics' (7% of total sales), and the 'Others' segment (6% of total sales). The 'Banking, Financial Services and Insurance' (10% of total sales) grew by 14.1% QoQ. The 'Tech, Media and Entertainment' (11% of total sales) saw a fall in revenues of 5.9% QoQ.

  • During the quarter, growth among geographies was not broad based. The revenues from US increased by 9.7% QoQ during 3QFY14. The revenues from Europe and from the Rest of the World (RoW) registered de-growth of 3.6% QoQ 1.8% QoQ.

    Revenue breakup
    (Rs m) 2QFY14 3QFY14 Change
    On the basis of industry
    Telecom 22,426 23,023 2.7%
    Manufacturing 9,066 9,307 2.7%
    Tech, Media and Entertainment 5,726 5,388 -5.9%
    Banking, Financial Services and Insurance 4,294 4,899 14.1%
    Retail, transport and logistics 3,340 3,429 2.7%
    Others 2,863 2,939 2.7%
    On the basis of geography
    US 20,995 23,023 9.7%
    Europe 15,746 15,185 -3.6%
    Rest of the world 10,974 10,777 -1.8%

  • Tech Mahindra's operating margin declined marginally by 0.1% QoQ to 23.2% at the end of 3QFY14. This was because of a significant increase expenses related to associate companies. On an absolute basis the operating profits increased by 2.3% QoQ.

  • Tech Mahindra's net profits improved by 40.6% QoQ during the quarter. The big jump in the net profit was due to a significant reduction in provisioning of previous years relating to the erstwhile Satyam. The company's provision for taxation also reduced due to the same reason.
What to expect?
At the current price of Rs 1,837 Tech Mahindra's share is trading at a multiple of 15.3 times its trailing twelve months earnings.

The company has had a good quarter at the topline. Volume growth was a healthy 3.3% QoQ. US dollar revenue growth was 4.4% QoQ. The company has a strong deal pipeline in place providing good revenue visibility. The company is witnessing good growth across verticals and service lines. However the management stated that the pace of discretionary IT spending was picking up slowly across geographies.

At any point of time the company works on 6 to 8 large deals but winning the same, is long process as the client's decision making process is lengthy. Despite this on a YoY basis the number of clients contributing over US$ 20 m has increased from 22 to 25 while the number of clients contributing over US$ 50 m has increased from 9 to 11.

The management has stated that if they had to make a tradeoff between margins and growth, they would focus on growth. However this approach has not had any adverse effect on the margins as of now. The company has a revenue target of US$ 5 bn by 2015.

Tech Mahindra will continue with its strategy of inorganic growth. The integration of Mahindra Engineering Services (MES) is currently in progress and the management stated that it would be completed soon.

Regarding the provisioning for contingencies of the erstwhile Satyam, the management stated that apart from India, most of the litigation issues have been resolved across different geographies.

The fundamentals of Tech Mahindra remain strong. However considering the risk profile of the company as well as the valuations we believe that most of the upside is priced in at current levels. Therefore we continue to maintain our 'Sell' view on the stock.

We would also like to suggest our subscribers to ensure that their allocation to equities is decided after keeping some cash aside. Further, they should also ensure that within their overall exposure to equities, no single share should comprise more than 5% of their equities portfolio.

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