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MOSL: TECH MAHINDRA (Buy)-Significant margin miss drives 8-11% earnings cut

TECH MAHINDRA: Significant margin miss drives 8-11% earnings cut

(TECHM IN, Mkt Cap USD9.2b, CMP INR640, TP INR770, 20% Upside, Buy)

 

• Profit below est. due to plummeting margins: 1QFY20 revenue grew 3.7% YoY CC (v/s est. of +3.8% YoY), EBIT declined 8% YoY (v/s est. of +10.5% YoY) and PAT increased 7% YoY (v/s est. of +17.9% YoY). EBIT margin declined 390bp QoQ to 11.4% (220bp miss to our est. of 13.6%). Margins were primarily impacted by a sharp decline in GPM, down 430bp QoQ to 28.8% (260bp below our est.). PAT at INR9.6b, was down 15% QoQ (9% miss to our est.), mainly due to operational miss; it was partially offset by higher other income at INR3.4b (v/s est. of INR2.6b).
• Subsidiaries and transition costs of large deals aid margin miss: Apart from the ~200bp margin impact from wage hikes, visas, 1QFY20 Communications' seasonality and hiring, additional decline in margins was attributed to the impact on subsidiaries amid challenges in Manufacturing/Automotives currently. TECHM started the year with an EBIT margin of 11.5% and though it is confident of surpassing 13% going ahead, it is still well below our earlier EBIT margin est. of 15%.
• Revenue outlook remains positive: Communications (42% of revenues) declined 3.2% QoQ, in line with our estimate. Enterprise segment (58% of revenues) was flat QoQ CC, dragged by 5.5% sequential decline in the Manufacturing segment (particularly China EV segment). TCV of deals worth USD475m for the quarter was dominated by Enterprise (USD375m); TCV of deals in Communications was ~USD100m. Continued traction in deal wins keeps our revenue growth estimate for FY20 intact.
• Valuation view: We cut our EPS estimates for FY20/FY21 by 11% / 8%, which follows 200bp/160bp cut in EBIT margins. After a sluggish start to the year the earnings growth outlook for FY20 has muted, but revenue growth remains crucial to both recovery in margins and uptick in valuation multiple. Deal wins and a healthy pipeline drive our expectation of acceleration in revenue growth for the remainder of the year. Over FY19-21, we expect USD revenue CAGR of 6.4% and earnings CAGR of 7.1%. Our TP of INR770 (20% upside) discounts forward earnings by 14x, the average multiple over the last five years. Maintain Buy.