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Tech Mahindra weak margins & free cash generation, ICICI Securites

TechM reported revenues of US$1,608mn, up 4.9% QoQ USD, in line with our estimates. In CC terms, revenues grew 5.4% QoQ. Growth was broad-based between communications (+4.8% QoQ CC) and enterprise (5.8% QoQ CC) verticals. For FY22, the company reported revenue growth of 17.4% YoY. Further, it reported strong deal wins at US$1.01bn (+43.6% QoQ, -3% YoY) led by CME vertical (US$645mn). For FY22, deal wins were at US$3.3bn, +48.4% YoY, with some large deals in CME (5G-related) and BFSI space.

Company reported an EBIT margin of 13.2% (-160bps QoQ), a miss to consensus / our estimates (14.3%/14.5%). Key reasons for the drop in margins were: lower utilisation, increased salary and retention costs, absence of one-offs from Q3FY22, and additional D&A charges. We have already assumed lower margins as compared to consensus by ~100-150bps for FY23/24. Going forward, 1) weak exit of margins in Q4FY22, 2) Higher man power costs, retention costs, 3) amortization charge, 4) return of travel & facility costs will weigh down margins in FY23. We believe TechM will deliver margins of 14% in FY23 (150 bps below consensus estimates).

Management guided to be more focused on driving organic growth in FY23 as they now have less white spaces given the acquisitions made over the past year. We build-in revenue growth 15.6%/11.5% for FY23E/FY24E as we believe the company’s investments in 5G and strong long-term relationships with service providers are yielding results. As our margin estimates were already lower than consensus, our EPS cut just stands at 2%/1% for FY22/23 for consensus it will be higher at 6-8%.

TechM is currently trading at 18x/15x over FY23E/FY24E EPS of Rs67/Rs78. We value the company at 16x FY24E earnings (vs 19x earlier) on account of increased integration risks given the recent acquisitions. Disciplined acquisition was a key component of TechM’s re-rating, one which requires close watch. FCF/PAT for the quarter reduced to 56% (vs 67% in Q3FY22).

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