Stock Review: Tech Mahindra

 

 

Tech Mahindra Ltd (TML) is a leading provider of solutions and services to the telecom industry. It is India's fifth largest software company. It serves telecom service providers, equipment manufacturers, software vendors and system integrators. Mahindra & Mahindra holds majority stake in the company while British Telecommunications (BT) is a partner in it.

 

High client concentration: TML's excess reliance on BT creates both advantages and disadvantages. On the positive side, deals (projects) from BT provide TML with a steady revenue stream. In recent times, BT has restructured many of its deals. The annual revenue from BT is estimated to be around £70-72 million.

On the negative side, since almost 35 per cent of the TML revenue comes from BT, much depends on how the latter is faring. If BT is not doing well then this has a direct impact on TML's margins.

Moreover, 77 per cent of TML's revenue is derived from its top five clients (of the 124 clients that it has). The geographical location of its clients is also skewed: 87 per cent of its revenue comes from western economies. This is a cause for concern since in the aftermath of the global financial crisis leading telecom players in the West are attempting to reduce their expenditure.

 

Sectoral uptrend: TML is benefiting from the turnaround in the information technology sector. Leading IT companies such as Infosys, TCS and Wipro have provided positive guidance.

Furthermore, like others, TML has also shifted its focus to the domestic market. In Q2FY11 TML was able to ink a deal with Bharti Airtel for its African mobile operations. It also struck a deal with Etisalat DB Telecom for providing customer service management, billing and other services. It also got a deal from a middle-rung client for a greenfield IT implementation.

 

Quarterly performance: TML posted a revenue of Rs 1,530 crore in Q2FY11 (a 34 per cent y-o-y rise). However, this included a one time pass through revenue of Rs 298.9 crore. If this component is excluded, revenue grew by just 8.16 per cent y-o-y.

 

Higher attrition rate: In Q2FY11 TML witnessed a higher attrition rate of 30 per cent compared to 27 per cent in Q1. However, this boosted the employee utilisation rate from 69 per cent in the previous quarter to 75 per cent in Q2.

 

Mahindra Satyam: This acquisition remains the biggest question mark on TML's future. To a large extent, TML's future depends on the successful integration of Mahindra Satyam (MSL). However, it is not yet clear whether the acquisition of Satyam has proved to be a positive for TML.

 

Valuation

TML has traditionally enjoyed higher return on equity (RoE) compared to other tier I IT companies. But operating margins is where it has lagged behind. This is primarily due to the segment in which it operates and due to its excessive reliance on a few large clients. But it appears that this is changing: in Q2FY11 35 per cent of revenue came from BT versus 45 per cent in Q1FY11.

According to analysts at Angel Broking, TML is expected to post an earnings per share (EPS) of Rs 47.8 and Rs 55.1 respectively in FY11E and FY12E.

The stock is currently trading at a price earnings ratio (PE) of 11.98 (December 2). This is lower than its five-year median PE of 13.4. Over the last five years, TML's EPS has grown at a compounded annual rate of 43.1 per cent. This gives it a price-earnings to growth (PEG) ratio of 0.28. Investors may buy the stock with at least a three-year horizon while keeping a close eye on the company's fundamentals.