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Tech Mahindra: Forex gain saves the day - Views on News from Equitymaster

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Tech Mahindra: Forex gain saves the day
Aug 24, 2015

Tech Mahindra has announced its first quarter results for FY16. The company reported a 2.9% QoQ growth in consolidated sales and a 43.2% QoQ rise in net profits. Here is our analysis of the results.

Performance summary
  • Consolidated net sales grew by 2.9% QoQ. In US dollar terms, growth in revenues was a meager 0.5% QoQ.
  • Operating expenses increased by 3.3% QoQ, largely as a result of steep increases in travel expenses (22.1% QoQ) and sub-contracting costs (16.2% QoQ). Thus, the operating profits were largely flat sequentially. The operating margin fell to 14.9% compared to 15.2% for 4QFY15.
  • The poor operating performance was compensated by a huge forex gain of Rs 932.1 m. This compared to a forex loss of Rs 1,540.9 m in 4QFY15 along with a sharp sequential fall in the tax rate helped the company's net profit rise by 43.2% QoQ.

Consolidated financial snapshot
(Rs m) 4QFY15 1QFY16 Change
Sales 61,168 62,938 2.9%
Expenditure 51,883 53,583 3.3%
Operating profit (EBITDA) 9,285 9,355 0.8%
Operating profit margin (%) 15.2% 14.9%  
Other income (653) 1,366  
Interest 177 124 -30.2%
Depreciation 1,721 1,733 0.7%
Exceptional items - -  
Profit before tax 6,734 8,864 31.6%
Tax 1,845 2,099 13.8%
Minority interest 170 15 -91.1%
Profit from assosiates 1 11 664.3%
Profit after tax/(loss) 4,720 6,761 43.2%
Net profit margin (%) 7.7% 10.7%  
No of shares (m)   961.5  
Diluted earnings per share   27.8  
P/E ratio#   20.3  
# On a trailing 12-months earnings basis

What has driven performance in 1QFY16?
  • In terms of the segmental break-up; growth was mainly hampered by the poor performance of the company's core telecom vertical. It must be noted that Q1 is a seasonally weak quarter for this segment. Otherwise the sequential revenue growth was fairly good.
    Revenue breakup
    (Rs m) 4QFY15 1QFY16 Change
    On the basis of industry
    Communications 33,826 33,168 -1.9%
    Manufacturing 10,093 10,762 6.6%
    Tech, Media and Entertainment 4,282 4,594 7.3%
    Banking, Financial Services and Insurance 5,566 6,294 13.1%
    Retail, Transport and Logistics 3,792 4,091 7.9%
    Others 3,609 4,028 11.6%
    On the basis of geography
    Americas 27,770 30,022 8.1%
    Europe 18,228 18,504 1.5%
    Rest of the world 15,170 14,413 -5.0%

  • In terms of operating performance, visa costs, and costs related to the integration of recent acquisitions kept operating margins under pressure. The recent acquisitions (LCC and Sofgen) have lower margins compared to the company. Thus, we believe the full year FY16 margins will be significantly lower than FY15.

  • The forex gain along with lower depreciation (as a percentage of sales) helped the sequential bottomline performance. The net profit was up by 43.2% QoQ. The net margin improved to 10.7%.
What to expect?

At the price of 563 the stock of Tech Mahindra trades at 20.3 times its trailing twelve months earnings.

The company's communication business continues to face a slowdown in decision making on account of M&A activity by telcos around the world. This trend will not end anytime soon. This vertical contributes over half of the company's revenues. Thus we believe, topline growth (on an organic basis) will take time to pick up.

The company continues to win deals in the enterprise space. Tech Mahindra signed about US $400 m worth of business in Q1FY16 (on a consolidated basis). Digital technologies have been the key growth driver. The company continues to invest heavily in digital enterprise solutions. The management believes the investments have begun yielding results. However, it is nowhere near significant enough to help boost margins. The management is targeting 10% of revenues from digital enterprise solutions in FY16.

We have no worries about the company's topline performance. However, margins will remain under pressure for the foreseeable future. We are currently updating our financial estimates for the company. Considering the risk profile of the business, the aggressive inorganic growth path that the management has chosen to follow 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.

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