Tech Mahindra Ltd. delivered a weak Q1 FY24 performance, with revenue declining 4.2% QoQ in constant currency to $1.6 billion, missing our estimate of a 2.5% decline. The weakness was primarily due to a slowdown in communication, media and entertainment (down 9.5% QoQ), while enterprise saw a marginal dip versus Q4 FY23.
Q1 Ebit margin (adjusted for client-specific write-off) was down 240 basis points QoQ at 8.8% (our estimate: 10.6%). Tech Mahindra delivered weak total contract value for the second straight quarter at $359 million, down 39% QoQ after a 25% QoQ decline in Q4.
Given the slowdown in communications business across IT services peers in the last few weeks, there was a concern about a weak revenue performance from Tech Mahindra. But we were still surprised by the sharp drop in CME vertical (38% of revenues in Q1) even after adjusting for the Comviva seasonality.
While we expect the segment to return to growth in Q2, we remain concerned about near-term demand in the space, given the adverse readthrough from the global ecosystem, including telecom hardware makers. We factor in USD revenue decline of 7.1% YoY in the vertical in FY24.
On the other hand, we expect the enterprise vertical to grow this year by 2.7% YoY in USD, though the weak TCV addition during the last two quarters will remain an overhang. With our base case factoring in a pick-up in FY25, we expect Tech Mahindra to deliver a USD revenue compound annual growth rate of 4.7% over FY23-25.
Due to the sharp dip in revenue, Tech Mahindra also saw a steep fall in profitability, exacerbated by a 200 bp one-time impact from bankruptcy of a client.
We expect the company’s profitability to improve from Q2 onward, partially through sharp cost control and headcount cuts despite high utilization. We see FY24E (adjusted)/FY25E Ebit margins at 10.6%/12.2%, resulting in a muted INR profit after tax CAGR of 5.5% in FY23-25E despite a low FY23 base (profit after tax -8.9% YoY).
While we expect a potential for performance improvement after the leadership refresh in June 2023, we believe this will take time given the macro headwinds and limited flexibility to invest in growth because of weak current profitability.
We remain on the sidelines as we feel the current valuation fairly factors in the uncertainties around growth and margin. We cut our FY24/FY25 earnings per share estimates by 8-10% on weak margin and muted outlook.
We remain ‘Neutral’ on the stock with a target price of Rs 1,080 (17 times FY25E EPS).
Click on the attachment to read the full report:
Motilal Oswal Tech Mahindra Q1FY24 Results Review.pdf
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