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Tech Mahindra: Forex loss dents profits - Views on News from Equitymaster

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Tech Mahindra: Forex loss dents profits
Nov 8, 2013

Tech Mahindra has announced its second quarter results for the financial year 2013-2014 (2QFY14). The company reported a 16.3% QoQ (quarter on quarter) growth in consolidated sales and a 4.7% 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 16.3% QoQ. In terms of US dollar, growth in revenues was 4.7% QoQ.
  • EBITDA (Earnings before interest, tax, depreciation and amortization) margin increased by 2.2% QoQ to 23.3% at the end of 2QFY14. That was because of the healthy sequential growth in revenues as well as a slower pace of growth in operating expenditure at 13% QoQ compared to the growth in sales. On an absolute basis, EBITDA grew by 28.5% QoQ.
  • The net profit grew by 4.7%QoQ. The reason for the slower growth in net profits compared to sales was a forex loss of Rs 206 m which led to a steep fall in other income by 81.6% QoQ. Additionally the effective tax rate for the quarter also increased to 28.3% compared to 25% for the previous quarter.
  • The company's employee base stood at 85,234 at the end of September 2013, recording a growth of 2.6% QoQ.
  • The total number of active clients increased from 567 at the end of 1QFY14 to 576 at the end of 2QFY14.

Consolidated Financial Snapshot
(Rs m) 1QFY14 2QFY14 Change 1HFY13 1HFY14 Change
Sales 41032 47715 16.3% 31748 88747 179.5%
Expenditure 32387 36604 13.0% 25069 68992 175.2%
Operating profit (EBITDA) 8645 11111 28.5% 6679 19756 195.8%
Operating Profit Margin (%) 21.1% 23.3%   21.0% 22.3%  
Other income 2073 381 -81.6% -813 2454  
Interest 223 242 8.3% 468 465 -0.8%
Depreciation 1174 1222 4.1% 902 2396 165.6%
Profit before tax 9321 10028 7.6% 4495 19349 330.4%
Tax 2328 2840 22.0% 836 5168 518.4%
Minority interest 130 4 -97.0% 0 134  
Profit from assosiates       2687 0  
Profit after tax/(loss) 6863 7184 4.7% 6347 14047 121.3%
Net profit margin (%) 16.7% 15.1%   20.0% 15.8%  
No of shares (m)         232.4  
Diluted earnings per shares         88.5  
P/E ratio#         18.8  
# On a trailing 12-months earnings basis

What has driven the performance in 2QFY14?
  • Tech Mahindra recorded a 16.3% QoQ growth in its net consolidated sales during the quarter. This was driven by a 13.9% QoQ growth in the 'Telecom' (47% of total sales). 'Manufacturing' (19% of total sales), 'Tech, Media and Entertainment' (12% of total sales), 'Banking, Financial Services and Insurance' (9% of total sales) and the 'Others' segment (6% of total sales) all grew by 16.3% QoQ each. The 'Retail, Transport and Logistics' (7% of total sales) saw a growth of 35.7% QoQ.

  • During the quarter, growth among geographies was broad based. The revenues from US increased by 13.7% QoQ during 2QFY14 while revenues from Europe registered a growth of 19.9% QoQ. Revenues from the Rest of the World (RoW) registered a growth of 16.3% QoQ.

    Revenue breakup
    (Rs m) 1QFY14 2QFY14 Change
    On the basis of industry
    Telecom 19695 22426 13.9%
    Manufacturing 7796 9066 16.3%
    Tech, Media and Entertainment 4924 5726 16.3%
    Banking, Financial Services and Insurance 3693 4294 16.3%
    Retail, transport and logistics 2462 3340 35.7%
    Others 2462 2863 16.3%
    On the basis of geography
    US 18464 20995 13.7%
    Europe 13130 15746 19.9%
    Rest of the world 9437 10974 16.3%

  • Tech Mahindra's operating margin increased by 2.2% QoQ to 23.3% at the end of 2QFY14. This was because of over the decline in employee related expenses as a percentage of sales. The cost of sales increased by 12.2% QoQ compared to the sales growth of 16.3% QoQ. On an absolute basis the operating profits increased by 28.5% QoQ.

  • The company's utilization levels (excluding trainees) decreased by 1% to 77% at the end of 2QFY14. The attrition level however increased by 1% to 16% at the end of 2QFY14.

  • Tech Mahindra's net profits improved by 4.7% QoQ during the quarter. The growth in net profits was lower than the sales growth due to the forex loss mentioned earlier. The management has stated that the tax rate would be lower going forward and this would help improve the net margin.
What to expect?
At the current price of Rs 1,668 Tech Mahindra's share is trading at a multiple of 18.8 times its trailing twelve months earnings.

The management confirmed that the merger of Mahindra Satyam with the company was progressing well and the synergies arising out of the merger were helping it win large deals across all verticals.

The company said that IT spending in the US had picked up while business confidence in Europe was improving albeit at a slow pace. However, the management cautioned that broad based growth across verticals and geographies would be difficult to achieve every quarter, due to several country and industry specific factors.

Tech Mahindra won 13 large deals in the quarter with a total size of about US$ 500 m. These deals are executable over the next 2-3 years. The management stated that the deal pipeline remained strong and continued to grow across all verticals.

Regarding specific verticals, the management stated that the fastest growth was being witnessed in Retail, Media and Banking. The growth in Telecom, the largest vertical for the company, was also broad based across geographies and service offerings. The management stated that the company was actively differentiating its service offerings from its competitors to maintain growth in this important vertical.

The management stated that they were building cash reserves as well as maintaining the company’s treasury stock for a large transformational opportunity in the future though they did not elaborate on this.

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 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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