Tech Mahindra: Clean up continues, a challenging year ahead!

25 Jan 2024 , 11:42 AM

Analysts of IIFL Capital Services maintain Sell on Tech Mahindra (TECHM) as the new management battles to turnaround the long-term growth and profitability profile amid a challenging demand environment and portfolio issues. Management reiterated that the improvement in growth and margins will be gradual, with limited visibility of a recovery in FY25 as of now, with TCV down 41% TTM YoY. In Q3, revenue beat (+1% vs IIFLe at -1%) was driven by one off product revenues and higher seasonality from Comviva, while Ebit margins (normalized 7%) continue to face headwinds. With the new organisation structure and leadership hiring behind us, building blocks for a turnaround are in place, but the task is challenging given a tepid demand environment and inability to heavily invest due to bloated cost structures. Analysts of IIFL Capital Services increase FY24-26 EPS by 2% to account for the revenue beat but remain up to 14% below Consensus. Analysts of IIFL Capital Services maintain SELL with a 12-month TP of Rs1,000 (was 980); as they believe that the turnaround may take longer than the Street anticipates while the stock is already pricing it in. 

Near-term demand remains muted; little visibility for FY25: 

TECHM continues to experience muted demand environment with elongated decision-making cycles, particularly in its Communications vertical. Presently, there is limited visibility of a significant pickup in FY25. There is broad-based slowdown across verticals, with the exception of Manufacturing (led by Auto/Aero) with no material pick up expected soon. 

Margin improvement could be an uphill task: 

As of Q3, TECHM is at 7% normalized Ebit margins with sub-con costs at decadal low, utilization near all-time high and headcount still declining by 7% YoY. Margin recovery is going to be gradual driven by optimisation of average resource cost, focus on higher margin geographies and better contract management. 

All eyes on strategy refresh: With Mohit Joshi taking over as the CEO, key focus is going to the strategy refresh that TECHM will announce in April. The new organisation structure has been put in place and most of the hiring for the same is done. While building blocks are in place, analysts of IIFL Capital Services believe the turnaround will be gradual, in the backdrop of a challenging macro environment. Analysts of IIFL Capital Services maintain SELL given that the valuations are already pricing in a recovery with little room for error. Key risk: Large deal wins.