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Tech Mahindra: Revenue growth remains intact - Views on News from Equitymaster
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Tech Mahindra: Revenue growth remains intact
Mar 3, 2015

Tech Mahindra has announced its third quarter results for the financial year 2014-2015. The company reported a 4.8% QoQ growth in consolidated sales and an 11.9% QoQ growth in net profits. Here is our analysis of the results.

Performance summary
  • Consolidated net sales grew by 4.8%% QoQ. In US dollar terms, growth in revenues was 2.7% QoQ.
  • Operating expenses increased by 4.6% QoQ, lower than the growth in sales. Thus, the EBITDA (Earnings before interest, tax, depreciation and amortization) increased by 5.7% QoQ. The EBITDA margin improved to 20.2% compared to 20% at the end of 2QFY15.
  • Due to the good operating performance, a lower tax rate and a one of gain from a subsidiary, the company's net profit grew by 11.9% QoQ.
  • The company has proposed a bonus issue of 1:1 per share.
  • The company has also proposed a stock split from Rs 10 to Rs 5 per share.

Consolidated financial snapshot
(Rs m) 2QFY15 3QFY15 Change 9MFY14 9MFY15 Change
Sales 54,879 57,517 4.8% 137,733 165,045 19.8%
Expenditure 43,906 45,916 4.6% 106,614 132,802 24.6%
Operating profit (EBITDA) 10,973 11,601 5.7% 31,119 32,243 3.6%
Operating profit margin (%) 20.0% 20.2%   22.6% 19.5%  
Other income 576 190 -66.9% 1,997 1,718 -14.0%
Interest 41 39 -4.9% 701 122 -82.7%
Depreciation 1,425 1,441 1.2% 3,792 4,393 15.8%
Exceptional items - -   1,200 -  
Profit before tax 10,083 10,311 2.3% 29,823 29,447 -1.3%
Tax 2,807 2,512 -10.5% 5,432 7,751 42.7%
Minority interest 80 31 -60.8% 245 140 -42.7%
Profit from assosiates - 285   - -  
Profit after tax/(loss) 7,196 8,053 11.9% 24,146 21,556 -10.7%
Net profit margin (%) 13.1% 14.0%   17.5% 13.1%  
No of shares (m)         240.0  
Diluted earnings per share         115.4  
P/E ratio#         24.8  
* On a trailing 12 months basis

What has driven performance in 3QFY15?
  • Considering the fact that the December quarter is seasonally weak for Indian IT firms, Tech Mahindra recorded a good 2.7% QoQ growth in sales in US dollar terms. In terms of verticals as well as geographies; the growth was fairly broad based.

    Revenue breakup
    (Rs m) 2QFY15 3QFY15 Change
    On the basis of industry
    Communications 28,537 29,276 2.6%
    Manufacturing 9,714 11,331 16.6%
    Tech, Media and Entertainment 4,555 4,199 -7.8%
    Banking, Financial Services and Insurance 5,323 5,637 5.9%
    Retail, Transport and Logistics 3,402 3,681 8.2%
    Others 3,348 3,451 3.1%
    On the basis of geography
    Americas 26,946 28,068 4.2%
    Europe 17,122 18,060 5.5%
    Rest of the world 10,866 11,388 4.8%

  • In terms of operating performance, the growth in employee, was contained in the quarter on a sequential basis as wage hikes were completed in the last quarter. This helped to boost margins in 3QFY15. However, maintaining margins at these levels will remain a challenge for the company.

  • The operating performance as well as a one-off gain from a subsidiary and a sequential fall in the tax rate helped to boost the bottomline. The net profit was up by 11.9% QoQ. The net margin improved to 14% compared to 13.1% at the end of 2QFY15.
What to expect?

At the price of 2,860 the stock of Tech Mahindra trades at 24.8 times its trailing twelve months earnings.

Tech Mahindra had a good quarter in 2QFY15 driven by the 2.7% QoQ growth in the topline in US dollar terms. The margins were higher sequentially due to lower employee costs (as a percentage of sales). The good broad based topline growth was the key reason for the company improving margins sequentially in this quarter.

The enterprise segment (i.e. non-telecom) continued to witness good traction in the quarter whereas the telecom segment continued to grow at below company average growth rates. This is along expected lines. The deal momentum continues to remain strong. The company signed quite a few large deals in the quarter across industries.

The company completed the formal process of merging Mahindra Engineering Services (MES) with itself in the quarter. The merger will boost the company's domain expertise in the auto, aerospace, defense and manufacturing industries.

The company's aggressive inorganic growth strategy continued in the quarter. Tech Mahindra acquired Lightbridge Communications Corporation (LCC), a globally recognised leader in providing network software services. This will further improve the company skills in its core telecom vertical. However, we view this growth strategy with caution and it remains to be seen if the company is able to integrate these acquisitions successfully while maintaining margins as well as growth.

The fundamentals of Tech Mahindra are sound. However, considering the risk profile of the company, the aggressive inorganic growth path that the management is following as well as the expensive valuations of the stock; we believe that there is no margin of safety for investors at current levels. Therefore, we maintain that investors should not buy the stock at these levels. Also investors should be aware that the stock split and bonus issue will not change the fundamentals of the business in any way.

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