Sharp stock gains, 5G uncertainty cap further upsides for Tech Mahindra

Improving margin trajectory, enterprise segment growth are positives

Shares of IT major Tech Mahindra hit a fresh all-time high on Tuesday on expectations of improving margin trajectory, steady sales growth led by a robust order book and potential 5G growth opportunities. Tech Mahindra’s margin performance has been volatile over the years, unlike other Tier 1 peers and has remained a key concern for investors. 

The software services exporter has guided for a 15 per cent margin at the Ebit or earnings before interest and taxes level in FY22. This is over 100-130 basis points above what the street has been working with and thus was positive for the stock. Moreover, the gains factor in wage hikes, increase in travel costs and facility expenses which are expected to make a comeback after remaining at lower levels amid the pandemic in the past two quarters. Profitability improvement would be driven by higher level of offshoring, lower subcontracting costs and better execution on portfolio companies.         

Even in the September quarter, the company had improved its margins by 400 basis points to 14.2 per cent which was at six quarter highs. The other trigger is on the revenue front. 

The management has guided for a high single digit revenue growth next year. While both its key segments are expected to contribute, the main growth driver in the near term will be the enterprise segment. Aided by strong deal wins and deal pipeline, the segment is expected to grow in double digits. 

The communications vertical, which is its largest, has been a laggard over the last few quarters. Analysts at JM Financial point out that even in the September quarter, the segment growth at 0.8 per cent on a sequential basis lagged the enterprise segment’s 4.3 per cent growth. The management expects the communication business to grow in single digit in FY22; growth trajectory however depends on the acceleration of spends on new technologies such as 5G, say analysts. 

The company hopes to get a higher share of the enterprise shift to digitisation and is developing products and platforms for the same. In addition to organic growth, it is also looking at inorganic opportunities which will help integrate capabilities as well as drive gains both on the revenue and cost fronts. Given its plans, execution will remain key if the company has to hit its growth targets while improving margins. 

Shares of Tech Mahindra which gained 3.5 per cent at close on Tuesday have been among the top performers in the Nifty IT index gaining close to 67 per cent over the last 6 months. The stock trades at 18.5 times its FY21 estimated price-to-earnings multiple which is at a steep discount to its peers like TCS and Infosys that trade at 31.5 times and 25.7 times respectively. Analysts at brokerage firm Motilal Oswal Research believe a recovery in the communication vertical is key for any re-rating in the stock multiple and retain a neutral rating. The 12-month consensus target price of analysts tracked by Bloomberg indicates a return potential of just 6 per cent from Friday’s closing price.