Stock Review: TECH MAHINDRA

Tech Mahindra's stock valuation seems to have bottomed out given its relatively stable performance during the current market turmoil. Its scrip has, in fact, gained 3% in the past three months as against the 1% drop.

The company has, however, lost more than one-third of its market value in the past 12 months despite a buoyant demand scenario in the IT sector. While the toptier IT players have been reporting increased business volumes and profit growth for the last four quarters, Tech Mahindra's performance has not seen much of a turnaround. Being a niche player, it depends solely on the telecom vertical and therein on UK-based BT, its biggest client. BT contributes over 44% to its revenue and its flat demand in the last few quarters has impacted Tech Mahindra's growth prospects. The situation may take some more time to reverse since the demand from BT is expected to remain at the current level for the next few quarters. Tech Mahindra has also not been able to grow its non-BT business. During the quarter, the non-BT business grew by just over 0.5%, excluding the impact of pass-through revenue from its clients. This indicates a persistent weakness in telecom spends, which are expected to resume not before the second half of 2011.

A firm cost structure in times of sluggish top-line reflects margin pressure. Elara Capital says margin improvement seems difficult due to transition costs associated with new deals. Net profitability is expected to fall since the company's tax rate is likely to shoot by 200-300 bps once tax exemption under the STPI scheme expires after March.
Tech Mahindra's growing presence in West Asia and Africa offers some solace. It offers BPO services to Bharti Airtel's African operations, which are expected to grow faster. With over 40% share in Bharti's total transactions, Tech Mahindra's growth is directly linked to the telecom player's success in the continent. Two days ago, it also won a development and maintenance contract from Vodafone Qatar.

At the last traded price of . 652.7, the stock attracted a trailing P/E of 10.5. Though this is at a deep discount to the P/Es of bigger IT players, an upside looks limited in the absence of a major near-term trigger.