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Tech Mahindra: Margin bloodshed continues
Jul 26, 2010

Tech Mahindra has announced its 1QFY11 results. The company has reported a 4% QoQ decline in sales and a 36.4% QoQ decline in its net profit. Here is our analysis of the results.

Performance summary
  • Net sales decline by 4% QoQ due to lower volumes in all key business segments.
  • Operating margins decline by 4.8% QoQ, to 18.8%, during the quarter. This is in line with the decline in sales and adverse currency movements.
  • Bottomline declines by 36% QoQ due to lower operating margins and a 66% QoQ decline in other income.
  • Adds around 1,743 employees during the quarter thereby taking the total strength to 35,267 at the end of June 2010.
  • Adds around 4 new clients during the quarter taking the total number of active clients to 117.


Consolidated Financial Snapshot
(Rs m) 4QFY10 1QFY11 Change
Sales 11,833 11,337 -4.2%
Expenditure 9,045 9,210 1.8%
Operating profit (EBITDA) 2,788 2,127 -23.7%
Operating Profit Margin (%) 23.6% 18.8%  
Other income 740 253 -65.8%
Interest 311 264 -15.2%
Depreciation 400 354 -11.4%
Profit before tax 2,817 1,762 -37.5%
Tax 542 312 -42.3%
Minority interest (6) (6) 7.0%
Profit after tax/(loss) 2,270 1,443 -36.4%
Net profit margin (%) 19.2% 12.7%  
No of shares (m) 124.1 124.1  
Diluted earnings per shares*#   57.5  
P/E ratio#   12.4  
# On a trailing 12-months earnings basis

What has driven performance in 1QFY11?
  • Tech Mahindra recorded a 4% QoQ decline in its sales during the quarter. Its 'telecom equipment manufacturer' (TEM) and 'others' segments witnessed sharp declines of 17% QoQ and 27% QoQ respectively. The 'telecom service provider' (TSP) segment saw a decline of 3% QoQ. Sales from the company's BPO segment also declined by 2% QoQ during the quarter. Overall, as per the management, the decline in the company's sales was mainly due to prolonged decision making cycles at key customers during the quarter.The management is expecting demand to start picking up from the US. As far as Europe is concerned, the company is in the middle of some large transformational deals where decision making is getting delayed due to their complex nature. The management is hopeful that these will come through in the coming quarters.

  • Tech Mahindra derived 32%, 55% and 13% of its revenues in FY10 from the US, Europe and ROW (rest of the world) regions respectively. The performance in the European market saw another quarter of bad performance as revenues fell by around 8% QoQ, thus underpinning the slow turnaround in the telecom industry in the region. Business from US has started rebounding with a 2% QoQ growth during the quarter. Sales from the ROW region declined by 4% QoQ during the quarter. The company entered into a number of deals during the quarter including its first deal in the Latin American region. It has also increased its engagement with its current clients thus taking the number of 'greater than US$ 10 m' clients to 13.

    Revenue breakup
    (Rs m) 4QFY10 1QFY11 Change
    On the basis of segments  
    Telecom service provider(TSP) 10,190 9,896 -2.9%
    Telecom equipment manufacturer (TEM) 703 584 -17.0%
    BPO service 682 669 -2.0%
    Others 258 188 -26.9%
    Total 11,833 11,337 -4.2%
    On the basis of geography      
    US 3,550 3,628 2.2%
    Europe 6,745 6,235 -7.6%
    Rest of the world 1,538 1,474 -4.2%

  • Tech Mahindra's operating margins fell by 4.8% QoQ due to adverse currency movements, higher average headcount and lower utilization levels during the quarter. The company's utilization levels declined to 69% as against 73% in 4QFY10. The interest costs were lower mainly due to the benefits of debt restructuring done in the previous quarters. The outstanding debt at the end of the quarter was Rs 14.6 bn and the cash outstanding was around Rs 1.9 bn.

  • Tech Mahindra's net profits declined by 36% QoQ during the quarter. This was mainly due to a 66% QoQ decline in other income and lower operating margins.

What to expect?
At the current price of Rs 738, the stock is trading at a multiple of 8.9 times our estimated FY13 earnings (ResearchPro subscribers, kindly click here).

The management is optimistic about the future and hopes to see a better revenue growth in the coming quarter. The business from US is showing signs of recovery and the management sees a healthy deal pipeline from there. Europe is in the middle of a slow decision making cycle. This is mainly client specific and is due to the complex nature of the large deals that are being brought to the table. For India, Asia Pacific and the Middle East regions, the larger telecom operators are trying to cut back costs due to increasing competition and are therefore tightening their purse strings in terms of new IT contracts. The new operators in these regions are holding back on their IT budgets due to the uncertainties from the regulators. As a result demand is expected to be slow from these regions.

Tech Mahindra will be announcing a wage hike next quarter in order to help control attrition. This will impact margins negatively. However, this will be offset to some extent by better revenue growth and higher utilization rates, as the management expects.

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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