Tech Mahindra Q3 Review: Brokerages Upbeat On Growth Prospects, Deal Wins; Stock Falls

Shares of Tech Mahindra Ltd. fell even as most brokerages reiterated their ‘buy' ratings citing a traction in 5G and digital technologies, consistent deal wins and margin recovery, among others.

The software services exporter saw its net profit increase 2.2% sequentially in the quarter ended December, but missed estimates. Its revenue and operating income also rose over the previous three months. And attrition inched up.

The company said it bagged several "strategic deals" in Europe, Africa, the U.S. and Philippines in the third quarter. Its strategic activity, according to Bloomberg data, includes 12 M&A deals, one investment and another deal worth Rs 21,490 crore over the past three months.

Tech Mahindra added $704 million in net new deal wins in the quarter. That's the fourth straight quarter of more than $700-million deals. The management, on a post-earnings call, said the deal pipeline remains robust. 5G, customer experience, data, analytics and cloud remain the key focus areas, and the company's actively strengthening its capabilities in these areas through M&A.

Shares of Tech Mahindra fell as much as 4.1%, the most since Jan. 27, to Rs 1,443 apiece. Of the 51 analysts tracking the company, 44 rate a ‘buy', five suggest a ‘hold' and two recommend a ‘sell', according to Bloomberg data. The 12-month consensus price target implies an upside of 23.9%.

Here's what brokerages made of Tech Mahindra's Q3 FY22 results:

IDBI Capital

• Maintains ‘buy' with a target price of Rs 1,800 apiece, implying a potential upside of 19%.

• IDBI Capital expects the communication segment to improve, led by traction in 5G, network modernisation and software transformation. In enterprise segment, we expect BFSI and Hi-tech to bounce back in coming quarters, led by traction in digital technologies.

• This, coupled with healthy client mining, consistent deal wins and headcount addition, will lead to 15% CAGR revenue growth over FY21-24E. Further, we expect margin to improve in coming years, led by rationalisation of subcontracting expense.

Nirmal Bang

• Maintains ‘buy' with a target price of Rs 1,952 apiece, implying a potential upside of 30%.

• Revenue growth and EBIT margin reflects its commitment to deliver sustainable profitable growth.

• Margin, affected due to higher subcontractor costs, supply-side challenges and lower utilisation, was almost in line with its guidance of 15%.

• Organic revenue growth of 4% gives us the confidence that FY22 will likely see Tech Mahindra record organic revenue growth around mid-teens, significantly ahead of initial expectations.

• Net new deal flow of $704 million fuels our expectation of a modest acceleration in revenue growth in FY23.

• Posts a steady Q3 and good prospects hinted at by the management, we have tweaked our estimates on revenue and EPS over FY22-FY24.

• Its valuation multiple is at a 25% discount to industry benchmark TCS' target PE multiple. After attending the analyst meet 2021, we had lowered our discount from 30% earlier on expectation of Tech Mahindra delivering steady industry-matching growth and improving margins and return ratios.

Dolat Capital

• Maintains ‘accumulate' rating with a target price of Rs 1,700 apiece from Rs 1,710, implying a potential upside of 13%.

• Tech Mahindra and other tier-I IT companies would continue to deliver strong revenue momentum over the next five-six quarters (translating into double-digit revenue growth in FY22-FY24) and thus would sustain current valuations of 20-25x which implies over 1.5-2x on PEG basis.

• The total contract value is also largely in line with consistent strong wins since last four quarters.

• Tech Mahindra says it has significant incumbent advantage and plans to capture all 5G and allied spends across verticals as evident from back-to-back healthy growth in three quarters in telco vertical.

• Attrition has been gradually increasing and is currently at 23.5% versus 12.4% in Q3FY21. The margin recovery will be prolonged as benefits from margin levers would play out gradually.

Prabhudas Lilladher

• Maintains 'buy' but cuts target price to Rs 1,942 from Rs 1,945, implying a potential upside of 29%.

• Growth momentum in communication is expected to remain healthy as telecom operator are adopting agile way of contracting by initially creating smaller milestones which add up to larger engagements.

• Headwinds from salary increases spread across Q3 and Q4 and normalisation of administrative expenses will weigh down margins in Q4.

• In FY23, margin levers pyramid optimization, increase in utilization, gradual reduction of subcontractor costs will aid margins.

Emkay Financial

• Maintains 'buy', cuts target price to Rs 1,900, still implying a potential upside of 26.2%.

• The deal pipeline remains healthy, and management expects healthy deal win momentum to continue.

• Management remains fairly confident of sustaining revenue growth momentum on the back of broad-based demand, robust deal wins, strong deal pipeline and contribution from mergers and acquisitions.

• Banking, financials, manufacturing, high-tech and healthcare verticals offer significant growth opportunities, and management sees potential to scale up the revenue run rate to over $1 billion for each.

• 'Buy' maintained considering the improving revenue growth trajectory, dividend payout and reasonable valuations post recent corrections.

Motilal Oswal

• Remains 'neutral' at a target price of Rs 1,600, implying a potential upside of 6%.

• New deal wins at $704 million (down 6% quarter-on-quarter) have stayed in a narrow range in recent quarters. Although, the management continues to see sustained traction in the deal momentum.

• Expects the company to deliver good top line performance, driven by continued spending from telecom operator/ equipment makers in preparation for the 5G deployment, along with demand-led strength in the enterprise vertical.

• The company should also see meaningful contribution to its FY23 revenues from recent acquisitions. With healthy deal bookings, a robust pipeline, and strong net additions, we expect Tech Mahindra to deliver an FY22–24 dollar revenue CAGR of 16% year-on-year.

• Continued pressure from the supply side, along with sales investments, would result in a dip in the EBIT margin in FY23 (estimates 50 basis points year-on-year). This would result in a miss on the company guidance of improving margin trajectory going forward.

• Continue to stay on the sidelines on Tech Mahindra as we see stronger business performance as balanced by elevated operational risks in a supply-constrained environment.