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MOSL:TECH MAHINDRA: Awaiting greater comfort on a margin recovery (TECHM IN, Mkt Cap USD12.4b, CMP INR1017, TP INR1035, 2% Upside, Neutral

5G unlikely to drive the upside in near term growth

• TECHM reported a 1QFY23 revenue of USD1.63b, up 3.5% QoQ CC (including an inorganic component of 40bp), ahead of our estimate of 2.8% QoQ. Reported growth was 1.5% QoQ in 1QFY23, led by a 1.8%/1% growth in enterprise (Technology and Retail)/Communications. While its revenue performance was good, it saw a big dip in its EBIT margin (down 220bp QoQ to 11%, 30bp below our estimate) due to a partial wage revision, lower utilization, and a normalization in SG&A spend. It reported a TCV of USD802m in 1QFY23, down 21% QoQ.
• Performance in 1QFY23 was aided by continued strength in the demand environment (in line with its peers), along with strong deal wins in 4QFY22. While we expect the company to sustain its good revenue performance over FY23 (MOFSLe of over 16% YoY), we continue to factor in a growth moderation in FY24, despite the continued positive commentary on 5G spends. This spend is likely to be in the medium term on account of growth and monetization uncertainty on the telco side, which will have a near to medium term impact. TECHM should deliver a USD revenue CAGR of 12% over FY22-24.
• We are concerned about TECHM's weak margin performance in 1QFY23 as it has twice missed its margin expectations in the last two quarters. As the company starts its recovery process, we see a high probability of it missing its 4Q exit margin rate of 14%, due to: a) a 100bp impact from a wage hike in 2QFY23, and b) relatively less support from utilization and fresher addition as levers as compared to its peers. We expect margin to remain at 12.3% in FY23, with the exit margin of 13.6%, 40bp below its guidance. We don't expect TECHM to normalize margin to 14% in FY24.
• We continue to stay on the sidelines on TECHM as we feel the current valuations fairly factor in better business dynamics against a moderation in profitability. We marginally tweak our estimates to account for lower margin. Our TP implies 14x FY24E EPS. We remain Neutral on the stock.

 

Revenue beat in 1QFY23, but large margin drop hits earnings

• TECHM reported a revenue of USD1.63b (up 3.5% QoQ in CC terms, up 1.5% QoQ, and up 3.1% in organic CC terms; est. 2.8% in CC terms).
• EBIT margin fell 220bp QoQ and 420bp YoY to 11%, 30bp below our estimate.
• PAT fell 25% QoQ to INR11.3b, 7% below our estimate, despite a lower tax rate (down 22.8%).

Key highlights from the management commentar

• In the CME vertical, while a weakening macro environment is coming up in client conversations, TECHM is not seeing any budget cuts and the deal pipeline remains strong.
• 5G spends remain robust. There is a strong focus on capacity building and carrier additions. It is not seeing any impact from macro-related concerns.
• The management aims to raise margin by 100-150bp per quarter to reach 14% exit margin in 4QFY23.

 

Valuation and view

• TECHM's high exposure to the Communications vertical remains a potential opportunity as a broader 5G rollout can result in a new spending cycle in this space. The company is seeing traction in 5G investments.
• We expect TECHM to deliver mid-teen growth in FY23. We value the stock at 14x FY24E EPS. We maintain our Neutral rating.