Tech Mahindra  (CMP: Rs774)            

Mkt Cap: Rs94.7bn; US$2.13bn       Bloomberg code (TECHM IN)

 

Key result highlights

·      Operationally in-line results – TechM reported revenues of US$259m up 1.9% qoq and 22.3% yoy; in INR terms, revenues of Rs11.8bn were flat qoq and up 13% qoq. EBIT margin declined by ~70bps qoq to 20.2% primarily on back of INR strength. Higher forex gains of US$13.5m led to positive surprise on net profits. Reported net profits at Rs2.3bn were up 31% qoq and down ~2% yoy. BT business grew 2% in USD terms and 4% in GBP terms.

·      Management commentary was cautiously optimistic – Management spoke of BT business remaining stable at GBP70-72mn per quarter while non-BT business showing good traction. 2nd largest client – AT&T was growing at a fast pace and management expects the same to continue. Also, domestic and middle east business are showing good traction. Management expects Europe to remain sluggish in the near to medium term. Management also indicated of margin headwinds from strong INR and upcoming wage hikes in coming few quarters.

·      Strong hiring indicate confidence on business pipeline – Company hired 3,100 employees in Q4 (10.2% of quarter ago base); over last year, company has hired 8,500 employees (34% of year ago base). Company has made 2,500 fresher offers for next year and expects to hire at least 4,500 employees in FY11. Strong hiring indicates management confidence on the business pipeline, in our view.

·      Key deal wins – (1) 5-yr managed services – total IT outsourcing deal from a new TSP in India, (2) a multi-year Application support system deal for better resource and process optimizations for North American telecom operator and (3) Customer care BPO deal from Indian telecom service provider.

Valuations and View: Quarterly results were operationally in-line with the expectations. We expect BT business to remain sluggish while non-BT business to grow better than the industry on the account of deal wins of the last two quarters and growth from AT&T. Our SOTP based 12month target price of Rs930 (from Rs910 earlier) is sum of organic business valuations of Rs655/share (based on 14x avg. FY11-12E EPS) and investment in Mahindra Satyam (M-Sat) at Rs275/share based on 25% holding company discount to the current market price.  Stock has underperformed all large cap IT services peers and broader market over last 3 months – it underperformed SENSEX by ~12% over last 1M and ~26% over last 3M. Adjusted for investment in M-Sat, TechM organic business is trading at ~12x FY11E and ~10x FY12E – on recurring earnings (net of BT restructured payment amortization). With reasonable valuations as also improving business prospects and the hiring pipeline, we upgrade the stock to Outperformer (from Underperformer).