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Tech Mahindra: 'Satyam' still a drag on profits - Views on News from Equitymaster
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Tech Mahindra: 'Satyam' still a drag on profits
May 3, 2010

Tech Mahindra has announced its FY10 results. The company has reported a 4% YoY growth in sales during FY10. Its net profits declined by 31% YoY. Here is our analysis of the results.

Performance summary
  • Sales decline marginally by 0.3% QoQ in 4QFY10. This was on account of reduced volumes in its ‘Telecom Service Provider (TSP)’ segment. However sales improve by 4% YoY in FY10 owing to improved volumes across all segments.
  • Operating margin remains flat QoQ at 23.6% during 4QFY10. Margins decline by 4.2% during the fiscal. This is on account of higher operating expenses and rupee’s appreciation against the US dollar.
  • Net profits grow by 31% QoQ during 4QFY10 on the back of higher operating margins coupled with increase in other income and lower interest payment. For FY10, profits decline by 31% YoY on account of huge interest burden post the acquisition of Satyam as well as significant increase in operating costs.
  • Adds around 3,120 employees during the quarter thereby taking the total strength to 33,520 at the end of March 2010.
  • The board recommends a final dividend of Rs 3.5 per share for FY10 (dividend yield of 0.5%).

Consolidated Financial Snapshot
(Rs m) 3QFY10 4QFY10 Change FY09 FY10 Change
Sales 11,873 11,833 -0.3% 44,647 46,254 3.6%
Expenditure 9,066 9,045 -0.2% 31,823 34,929 9.8%
Operating profit (EBITDA) 2,807 2,788 -0.7% 12,824 11,325 -11.7%
Operating Profit Margin (%) 23.6% 23.6%   28.7% 24.5%  
Other income 6 740   (378) 754  
Interest 459 311 -32.3% 25 2,184  
Depreciation 331 400 20.7% 1,097 1,339 22.0%
Profit before tax 2,023 2,817 39.3% 11,324 8,556 -24.4%
Tax 285 542 90.1% 1,179 1,440 22.1%
Minority interest (9) (6)   (1) (28)  
Extraordinary income/(expense) - -   - 85  
Profit after tax/(loss) 1,729 2,270 31.3% 10,144 7,004 -31.0%
Net profit margin (%) 14.6% 19.2%   22.7% 15.1%  
No of shares (m)         122.3  
Diluted earnings per shares         57.3  
P/E ratio         13.5  
# On a trailing 12-months earnings basis

What has driven performance in FY10?
  • Tech Mahindra recorded a marginal decline of 0.3% QoQ in sales during 4QFY10. During FY10, sales grew by around 4% YoY. Growth during the year was driven by its telecom service provider (TSP), telecom equipment manufacturer (TEM) and BPO segments. The TSP business (86% of sales) witnessed sluggish growth of 3% YoY during the fiscal. TEM business (6% of sales) recorded a healthy growth of almost 10% YoY. The BPO segment (3% of sales) grew by 6% on the back of the company’s renewed focus on the same. Though the recovery appears to be muted for the global telecom industry plaguing its core IT services, Tech Mahindra is upbeat about the demand for its BPO services. It has been significantly ramping up its headcount for this business over the past two quarters in order to tap this demand.

  • The company derived 29%, 59% and 12% of its sales in FY10 from the US, Europe and ROW (rest of the world) regions respectively. The European market saw further weakness as sales fell by 9% YoY. This underpinned the slow turnaround in the telecom industry in the region. The company also saw a lot of traction from the Middle-East, African, North American and Indian markets. It entered into a number of deals including a 5-year managed services contract for deployment and maintenance of IT applications and infrastructure with an Indian operator.

    Revenue breakup
    (Rs m) FY09  FY10  Change 
    On the basis of segments      
    Telecom service provider (TSP) 38,749 39,741 2.6%
    Telecom equipment manufacturer (TEM) 2,409 2,644 9.7%
    BPO 2,502 2,660 6.3%
    Others 986 1,210 22.6%
    Total 44,647 46,254 3.6%
    On the basis of geography      
    US 11,162 13,414 20.2%
    Europe 29,913 27,290 -8.8%
    Rest of the world 3,572 5,550 55.4%

  • Operating margins fell by 4.2% YoY to 24.5% in FY10. Despite a higher utilisation rate, margins fell due to increased employee costs and rupee’s appreciation against the dollar and the pound, the company expects the margin pressure to continue going forward. Nevertheless, a more favorable onsite-offshore effort mix had a positive impact on the margins. Offshore sales accounted for 62% of total sales as against 60% in FY09.

  • Tech Mahindra’s net profits grew by 31% QoQ during 4QFY10. This was primarily helped by a huge other income component of Rs 740 m largely from forex gains on currency hedges. Profit fell by 31% YoY in FY10 due to huge interest costs of Rs 2.2 bn. The company had a debt of Rs 13.7 bn on its books at the end of March 2010, lower from Rs 17.4 billion in 3QFY10. Depreciation also increased by 22% YoY in FY10 due to facilities being used at its large SEZ in Pune.

What to expect?
At the current price of Rs 775, the stock is trading at a multiple of 10.8 times our estimated FY12 earnings. Tech Mahindra’s FY10 numbers are fairly in line with our estimates. While sales are 1% lower than our estimates, net profits are higher by around 4%.

During the conference call, the company’s management was enthused with the recovery in its BPO business, and growth in North America leveraging on its relationship with AT&T. Tech Mahindra won the AT&T Supplier Award in 2010 for outstanding performance and service. This showed commitment from the American telecom giant to the Indian tech major dispelling concerns which came on the back of a recent divestment of its shares in the company. Tech Mahindra added several clients during the year, taking the total number of active clients to 113. While the US market is increasingly gaining prominence with over 20% YoY growth in FY10, most of the incremental growth came from the Rest of the World segment (which includes India, Middle East) which grew by 55% YoY during FY10. However, most of the deals in the emerging markets appear to be lumpy and for low-end IT services like system integration and BPO.

Europe remains plagued by the economic downturn and is not witnessing significant uptick in IT spending. Tech Mahindra expects revenue from its largest client i.e., BT to be in the range of Pound 70-72 m per quarter going forward. This is despite the fact that BT restructured a few of its long term projects with the company. Despite the fact the overall pie of IT contracts from BT has decreased, the management stated that the company now has a larger share of the pie. During FY10, the company’s non BT revenue saw a 16% YoY growth. However besides BT, the company experienced some delays as decision cycles from clients to award new deals were prolonged and caution remained in the market.

The management expects capex to be in the range of US$ 100 m over the next 3 years and plans to keep repaying its Rs 13.7 bn debt depending on other pressing cash requirements. Going forward, currency volatility, high attrition rate and pressure on margins due to salary hike will remain a concern for the company.

Despite the decline in the stock’s valuations, we believe that it is not prudent to form a definite view on the company until there is more clarity on Mahindra Satyam.

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