Tech Mahindra (TECMAH)

CMP: | 848 Target: | 1040 (23%) Target Period: 12 months BUY

October 24, 2020 Robust margin expansion... ’s (TechM) revenues increased 2.9% QoQ in constant currency terms (above our estimate of 1.1% QoQ in CC terms) mainly led by

0.8% QoQ growth in communication revenues and 4.3% QoQ growth in Particulars enterprise revenues. The company also reported a healthy expansion in EBITDA margins (up 397 bps QoQ to 18.2%) mainly led by higher utilisation, Particular Amount offshoring and rationalisation of SG&A expenses. The order book improved Market Cap (| Crore) 81,951.9 45.2% QoQ to US$421 million. Total Debt (| Crore) 2,428.2

Healthy deal pipeline, traction in digital to drive growth Cash and Invest (| Crore) 8,760.6 Update Result EV (| Crore) 75,619.5 TechM saw healthy growth in revenues in the current quarter mainly led by 52 week H/L 888 / 470 robust growth in enterprise segment (led by banking & technology vertical). Equity capital 435.9 Going forward, the company believes manufacturing has bottomed out and could see healthy traction led by improving growth in engineering side Face value | 5

(especially in auto). In addition, TechM is witnessing improving trends in retail and utility. Further, on the communication side, expect IT spends to Key Highlights improve led by 5G, digital, customer experience, AI, cloud and network  Leadership in communication vertical operations. Further, TechM is seeing healthy funnel in holistic to drive long term growth. Enterprise transformation of telecom service providers and the company is in advanced segment to benefit from improved stages with many customers in transformational projects. In addition, digital revenues improving digital, healthy deal wins, 5G in enterprise and pruning of low

return geographies bode well for the longer term trend in revenues. Hence,  Revise our EPS estimates upwards although we expect revenues to be under pressure in FY21E, we expect an led by improving margin trajectory improved performance in FY22E & FY23E.  Maintain BUY recommendation with Margins to witness gradual improvement revised target price of | 1040. Industry leading revenue growth can EBIT margins in the quarter improved 414 bps to 14.2%. Going forward, the further re-rate stock company expects margins to sustain at these levels. The company believes that despite headwinds (like higher variable pay & travel cost) it has multiple

levers in terms of sustaining and improving margins, going forward. Some

levers are synergies in portfolio companies (like systems, back-end, Research Equity Retail Research Analyst process), automation, reduction of sub-contracting cost (from current 13%) – higher offshoring, pruning of low return geographies and benefits of large Devang Bhatt deal won in previous quarter. Hence, we expect EBIT margins to improve [email protected]

157 bps YoY to 13.2% in FY21E and another 160 bps in FY21E-23E to 14.8%.

Valuation & Outlook Securities The company is well poised to capture improving IT spend in communication and digital traction on the enterprise side. Further, in the ICICI

long term, we believe TechM will be a key beneficiary of 5G opportunities. This, coupled with improving margin trajectory led by cost rationalisation prompt us to revise EPS estimates upwards. Hence, we maintain BUY with a revised target price of | 1040 (15x PE on FY23E EPS).

Key Financial Summary

Key Financials FY19 FY20 FY21E FY22E FY23E CAGR (FY20-23E) Net sales 34,742 36,868 37,536 40,490 44,787 6.7% EBITDA 6,337 5,726 6,419 7,450 8,375 13.5% EBITDA Margin (%) 18.2 15.5 17.1 18.4 18.7 Net Profit 4,298 4,033 4,402 5,169 5,923 13.7% EPS (|) 47.7 45.9 50.0 58.8 67.3 P/E 17.8 18.5 16.9 14.4 12.6 RoNW (%) 21.2 18.5 18.3 18.9 19.0 RoCE (%) 23.6 19.1 18.7 19.8 20.3 s Source: Company, ICICI Direct Research Result Update | Tech Mahindra ICICI Direct Research

Exhibit 1: Variance Analysis Q2FY21 Q2FY21E Q2FY20 YoY (%) Q1FY21 QoQ (%) Comments

Dollar revenues increased 4.8% QoQ mainly led by equal Revenue 9,371.8 9,208.4 9,069.9 3.3 9,106.0 2.9 growth in demand and receding supply side constraint

Employee expenses 6,424.5 6,491.9 6,389.3 0.6 6,510.5 -1.3

Gross Margin 2,947.3 2,716.5 2,680.6 9.9 2,595.5 13.6 Gross margin (%) 31.4 29.5 29.6 189 bps 28.5 295 bps SG&A expenses 1,244.3 1,261.6 1,179.7 5.5 1,295.3 -3.9

EBITDA 1,703.0 1,454.9 1,500.9 13.5 1,300.2 31.0

The improvement in margins was due to 160 bps led by supply & demand side improvement and 160 bps due to EBITDA Margin (%) 18.2 15.8 16.5 163 bps 14.3 397 bps higher offshoring, lower subcontracting cost, lower seasonality and utilisation

Depreciation & amortisation 371.7 383.2 341.5 8.8 383.2 -3.0 EBIT 1,331.3 1,071.7 1,159.4 14.8 917.0 45.2 EBIT Margin (%) 14.2 11.6 12.8 142 bps 10.1 414 bps The company had one-time income tax receipt in the Other income (less interest) 77.6 345.0 178.1 -56.4 365.8 -78.8 previous quarter. As a result, the fall in other income looks significant PBT 1,408.9 1,416.7 1,337.5 5.3 1,282.8 9.8 Tax paid 346.2 361.3 226.5 52.8 327.6 5.7 PAT 1,064.6 1,072.3 1,124.0 -5.3 972.0 9.5

Adjusted PAT 1,064.6 1,072.3 1,124.0 -5.3 972.0 9.5 PAT broadly in line with our estimate

Source: Company, ICICI Direct Research Exhibit 2: Change in estimates FY21E FY22E FY23E Comments (| Crore) Old New % Change Old New % Change Introduced

Improving growth in communication and enterprise Revenue 37,244 37,536 0.8 40,238 40,490 0.6 44,787 prompt us to revise revenue estimates upwards

EBITDA 5,587 6,419 14.9 6,438 7,450 15.7 8,375 Considering multiple margin levers, we revise our margin EBITDA Margin (%) 15.0 17.1 210 bps 16.0 18.4 240 bps 18.7 estimates upwards

PAT 3,838 4,402 14.7 4,486 5,169 15.2 5,923 EPS (|) 43.6 50.0 14.7 51.0 58.8 15.2 67.3

Source: Company, ICICI Direct Research

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Conference Call Highlights

 Revenue outlook: On the communication side, the company expects IT spends to improve led by 5G, digital, customer experience, AI, cloud and network operations. In addition, TechM is seeing healthy funnel in holistic transformation of telecom service providers while the company is in advanced stages with many customers in transformational projects. In addition, from the enterprise side, the company believes manufacturing has bottomed out and will see healthy traction, going forward. TechM is also seeing improving trends in retail and utility. In terms of technology, the company is seeing improving demand from artificial intelligence, machine learning, cybersecurity, customer experience and automation. In addition, this quarter growth was led by BPO but the company expects IT related growth to claw back in coming quarters. Further, in terms of geography, the company expects Europe to register improving trajectory

 Margin snapshot: EBIT margins in the quarter improved 414 bps to 14.2%. Going forward, the company expects margins to sustain at these levels. TechM believes that despite headwinds (like higher variable pay & travel cost) it has multiple levers in terms of sustaining and improving margins, going forward. Some levers are synergies in portfolio companies (like systems, back-end and process), automation, reduction of sub-contracting cost (from current 13%) higher offshoring, pruning of low return geographies and benefits of large deal won in the previous quarter

 Deal wins: The communication order book increased from US$105 million to US$208 million due to low base last quarter. Enterprise order increased ~16% due to closure in deal wins. The company is seeing improving funnel in communication across a broad range of holistic transformation of telecom service providers led by better traction in network, 5G stack, digital transformation while it is in advanced stages with many customers in communication segment

 Employee update: TechM saw addition of 842 employees in Q2FY21 leading to total employees of 1,24,258. The growth was largely due to BPO business offset by a decline in software professionals

 DSO position: DSO days declined from 107 in Q1FY21 to 97 days in Q2FY21. We believe DSO days were due to advances by customers and could see an increase in subsequent quarters

 Acquisitions : The company’s wholly owned subsidiary Tech Mahindra (Singapore) Pte Ltd has agreed to acquire 100% equity shares in Tenzing Ltd and Tenzing Australia Ltd (Tenzing Group) for US$29.5 million (~| 217 crore) at EV/sales of 1.1x. The target entity is engaged in the business of digital transformation & technology services with a BFSI focus. The transaction is expected to be completed by November 2020. The company has also done one more acquisition and agreed to acquire 100% stake in Momenton Pty. Ltd for AU$14.3 million (| 74.7 crore) at EV/sales of 1.32x. Momenton is a cloud and engineering services provider with a BFS focus. The acquisition will enhance TechM’s digital transformation capabilities and provide it a scaled up presence in the Australian BFS market. The transaction is expected to be completed by March 31, 2021

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Key Metrics

Exhibit 3: Geography wise break-up ES Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Revenue by geography (%) Americas 48.5 48.4 47.7 49.3 48.4 Growth in revenues was across geographies led by Europe 26.7 27.0 26.5 25.8 25.2 Americas & Rest of World Rest of World 24.9 24.6 25.8 24.9 26.4

Growth QoQ (%) Americas 5.2 4.9 -5.7 -3.6 2.9 Europe -0.2 6.3 -6.1 -9.2 2.4 Rest of World 3.6 3.8 0.4 -10.0 11.1

Source: Company, ICICI Direct Research

Exhibit 4: Industry wise break-up Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Revenue by verticals (%) Telecom 41.1 42.6 40.8 40.0 39.3 Manufacturing 18.0 17.3 17.7 16.8 16.1 Technology, media & entertainment and banking Technology,media & entertainment 8.1 7.6 7.4 9.0 9.8 segment to register healthy QoQ growth Banking,financial services & insurance 13.0 13.2 15.3 15.7 16.8 Retail, transport & logistics 7.0 7.2 7.3 7.3 7.5 Others 12.8 12.2 11.5 11.2 10.9

Growth QoQ (%) Telecom 1.0 8.9 -8.4 -8.6 3.0 Manufacturing -4.2 1.0 -2.1 -11.5 0.4 Technology,media & entertainment 10.0 -1.4 -6.8 13.4 14.1 Banking,financial services & insurance 4.8 6.7 10.9 -4.3 12.1 Retail, transport & logistics 16.5 8.1 -3.0 -6.7 7.7 Others 11.0 0.2 -9.8 -9.2 2.0

Source: Company, ICICI Direct Research

Exhibit 5: Client & human resource matrix Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Client Metrics ≥ $1 million clients 437 446 446 451 460 ≥ $5 million clients 155 164 160 161 165 ≥ $10 million clients 80 83 85 81 82 Utilisation increased 300 bps QoQ while attrition ≥ $20 million clients 49 50 49 48 50 dipped 300 bps QoQ in the quarter ≥ $50 million clients 22 22 22 21 21

Headcount, Attrition, Utilization Total Employees 131522 130839 125236 123416 124258 IT Attrition (LTM) 21.0 20.0 19.0 17.0 14.0 IT Utilization % (Excluding Trainees) 83.0 85.0 84.0 82.0 85.0

Source: Company, ICICI Direct Research

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Financial story in charts

Exhibit 6: Dollar revenues trend

40 6500 5972 5472 5182 5072 5500 43514771 4971 30 4037 4500 3686 19.0

20 % 3500 1218

$ $ million 9.5 9.6 1353 7.8 7.6 12471287 7.9 9.1 2500 1261 5.7 7.3 1224 3.3 4.3 1268 4.2 1295 4.3 12081265 10 1500 1.9 1.9 2.1

500 0

FY15 FY16 FY17 FY18 FY19 FY20

FY21E FY22E FY23E

Q2FY19 Q3FY19 Q4FY19 Q2FY20 Q3FY20 Q4FY20 Q2FY21 Q1FY19 Q1FY20 Q1FY21 Dollar revenue Growth, YoY Source: Company, ICICI Direct Research

Exhibit 7: Revise our margin estimates for FY21E, FY22E and FY23E

25.0% 19.3% 18.5% 18.8% 18.4% 18.4%18.7% 20.0% 18.2% 18.2%17.1% 16.1% 16.4% 16.5%16.2% 15.5% 14.4%15.3% 14.2% 14.3% 15.0% 15.2%

% 10.0%

5.0%

0.0%

FY15 FY16 FY17 FY19 FY18 FY20

FY21E FY23E FY22E

Q1FY19 Q2FY19 Q4FY19 Q1FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY19 Q2FY20 EBITDA margin

Source: Company, ICICI Direct Research

Exhibit 8: PAT trend

6500 5923 5169 5500 4402 4500 3800 4298 4033 2993 3500 2628 2812

| crore | 2500 1203 1146 1500 898 1064 1133 1124 972 1065 959 804

500

FY15 FY16 FY17 FY19 FY20 FY18

FY21E FY22E FY23E

Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q1FY19 Q2FY19 Q3FY19

Source: Company, ICICI Direct Research

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Exhibit 9: Three year chart

15,000 1,500 13,000 1,000 11,000 9,000 500 7,000

5,000 0

Jun-18 Jun-19 Jun-20

Sep-19 Sep-17 Sep-18 Sep-20

Dec-18 Dec-19 Dec-17

Mar-18 Mar-20 Mar-19

Nifty (L. H.S) Price (R.H.S)

Source: Company, ICICI Direct Research

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Financial summary

Exhibit 10: Profit and loss statement | crore Exhibit 11: Cash flow statement | crore (Year-end March) FY20 FY21E FY22E FY23E (Year-end March) FY20 FY21E FY22E FY23E Net sales 36,868 37,536 40,490 44,787 Profit before Tax 5,058 5,566 6,550 7,516 Growth (%) 6 2 8 11 Add: Depreciation 1,446 1,472 1,588 1,756 (Inc)/dec in Current Assets (2,335) (410) (760) (1,651) COGS (employee expenses) 25,974 25,900 27,533 30,455 Inc/(dec) in CL and Provisions 1,813 339 710 1,032 Gross profit 10,893 11,636 12,957 14,332 Taxes paid (1,513) (1,225) (1,441) (1,654) S,G&A expenses 5,167 5,217 5,507 5,957 CF from operating activities 4,358 5,173 6,109 6,253 (Inc)/dec in Investments 1,298 (1,000) (1,000) (1,000) Total Operating Expenditure 31,142 31,117 33,040 36,412 (Inc)/dec in Fixed Assets (829) (938) (1,012) (1,120) EBITDA 5,726 6,419 7,450 8,375 Others 253 761 730 939 Growth (%) (10) 12 16 12 CF from investing activities 1,029 (1,177) (1,282) (1,181) Issue/(Buy back) of Equity 47 - - - Depreciation 1,446 1,472 1,588 1,756 Inc/(dec) in loan funds 193 - - - Interest 192 192 192 192 Dividend paid & dividend tax (2,492) (2,201) (1,809) (2,073) Other Income 1,192 811 880 1,089 Inc/(dec) in debentures - - - - PBT 5,281 5,566 6,550 7,516 Finance charges (426) (192) (192) (192) Total Tax 1,160 1,225 1,441 1,654 CF from financing activities (4,466) (2,393) (2,001) (2,265) Exceptional item - - - - Net Cash flow 921 1,604 2,826 2,808 PAT 4,033 4,402 5,169 5,923 Cash by acquisition - - - - Growth (%) (6) 9 17 15 Opening Cash 2,043 3,148 4,752 7,577 EPS (|) 45.9 50.0 58.8 67.3 Cash carried to B/S 3,148 4,752 7,577 10,385

Source: Company, ICICI Direct Research Source: Company, ICICI Direct Research

Exhibit 12: Balance sheet | crore Exhibit 13: Key ratios | crore (Year-end March) FY20 FY21E FY22E FY23E (Year-end March) FY20 FY21E FY22E FY23E Liabilities Per share data (|) Equity Capital 436 436 436 436 EPS 45.9 50.0 58.8 67.3 Share application money - - - - Cash EPS 62.3 66.8 76.8 87.3 Reserve and Surplus 21,377 23,578 26,938 30,788 BV 248.0 273.0 311.2 355.0 Total Shareholders funds 21,813 24,014 27,374 31,224 DPS 15.0 25.0 20.6 23.6 Minority Interest 393 328 262 197 Cash Per Share 35.8 54.0 86.2 118.1 Total Debt 2,428 2,428 2,428 2,428 Operating Ratios (%) Other long term liabilities 4,043 4,043 4,043 4,043 EBITDA Margin 15.5 17.1 18.4 18.7 Total Liabilities 28,677 30,813 34,107 37,891 PAT Margin 10.9 11.7 12.8 13.2 Assets Net Block 3,834 3,300 2,725 2,088 Return Ratios (%) Capital WIP 50 50 50 50 RoE 18.5 18.3 18.9 19.0 Investments 5,848 6,843 7,837 8,832 RoCE 19.1 18.7 19.8 20.3 Deferred tax assets 844 844 844 844 RoIC 21.5 25.5 31.1 35.1 Goodwill on consolidation 3,388 3,388 3,388 3,388

Debtors 7,581 7,882 8,098 8,957 Valuation Ratios (x) Loans and Advances (short) - - - - P/E 18.5 16.9 14.4 12.6 Other non-current assets 4,175 4,175 4,176 4,176 EV / EBITDA 13.2 11.4 9.3 7.8 Cash 3,148 4,752 7,577 10,385 EV / Net Sales 2.1 1.9 1.7 1.5 Other current assets 6,799 6,907 7,450 8,241 Market Cap / Sales 2.2 2.2 2.0 1.8 Total Current Assets 23,176 26,189 30,774 36,231 Price to Book Value 3.4 3.1 2.7 2.4 Trade payables 3,257 3,316 3,577 3,956 Current liabilities 4,983 5,255 5,669 6,270 Solvency Ratios Provisions 436 444 479 530 Debt/EBITDA 0.4 0.4 0.3 0.3 Total Current Liabilities 8,676 9,015 9,724 10,756 Current Ratio 1.7 1.6 1.6 1.6 Application of Funds 28,677 30,813 34,107 37,891 Quick Ratio 1.7 1.6 1.6 1.6

Source: Company, ICICI Direct Research Source: Company, ICICI Direct Research

ICICI Securities | Retail Research 7 Result Update | Tech Mahindra ICICI Direct Research

Exhibit 14: ICICI Direct coverage universe (IT) EPS (|) P/E (x) RoCE (%) RoE (%)

Company Cmp (|) TP (|) Rating Mcap (| Cr)

FY20 FY21E FY22E FY23E FY20 FY21E FY22E FY23E FY20 FY21E FY22E FY23E FY20 FY21E FY22E FY23E HCL Tech (HCLTEC) 852 960 Buy 2,31,230 40.8 45.2 52.2 59.3 21 19 16 14 23.0 23.6 24.5 24.7 21.6 20.5 20.7 20.4 (INFTEC) 1,122 1,350 Buy 4,78,529 38.9 45.9 49.2 56.4 29 24 23 20 30.8 33.5 33.3 35.3 25.2 27.2 26.9 28.4 TCS (TCS) 2,686 3,300 Buy 10,07,891 86.2 87.2 103.8 118.0 31 31 26 23 43.5 44.5 49.0 52.9 37.5 37.1 42.3 45.6 Tech M (TECMAH) 848 1,040 Buy 81,952 45.9 50.0 58.8 67.3 18 17 14 13 19.1 18.7 19.8 20.3 18.5 18.3 18.9 19.0 (WIPRO) 342 435 Buy 1,95,535 16.6 18.1 19.8 22.2 21 19 17 15 19.3 21.0 22.4 24.5 17.4 18.6 19.9 21.9 (MINCON) 1,394 1,680 Buy 22,966 38.3 58.8 68.0 76.3 36 24 21 18 23.0 29.7 30.0 29.6 20.0 25.5 25.4 24.6 LTI (LTINFC) 3,065 3,570 Buy 53,510 86.6 105.9 124.8 146.2 35 29 25 21 30.7 31.8 31.3 30.9 28.1 28.3 28.0 27.5 Coforge (NIITEC) 2,381 2,690 Hold 14,426 71.4 75.7 94.4 110.3 33 31 25 22 23.0 25.5 27.0 27.6 18.5 20.1 22.0 22.6 Infoedge (INFEDG) 3,647 3,555 Hold 46,898 26.8 27.8 33.4 136 131 109 18.0 10.6 12.0 13.5 7.9 8.9 Teamlease (TEASER) 2,258 2,205 Buy 3,866 20.5 48.2 62.8 110 47 36 15.0 12.7 14.1 6.5 12.9 14.5

Source: Company, ICICI Direct Research

ICICI Securities | Retail Research 8 Result Update | Tech Mahindra ICICI Direct Research

RATING RATIONALE ICICI Direct endeavors to provide objective opinions and recommendations. ICICI Direct assigns ratings to its stocks according to their notional target price vs. current market price and then categorizes them as Buy, Hold, Reduce and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock Buy: >15% Hold: -5% to 15%; Reduce: -15% to -5%; Sell: <-15%

Pankaj Pandey Head – Research [email protected]

ICICI Direct Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC, Andheri (East) Mumbai – 400 093 [email protected]

ICICI Securities | Retail Research 9 Result Update | Tech Mahindra ICICI Direct Research

ANALYST CERTIFICATION

I/We, Devang Bhatt, PGDBM, Research Analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. It is also confirmed that above mentioned Analysts of this report have not received any compensation from the companies mentioned in the report in the preceding twelve months and do not serve as an officer, director or employee of the companies mentioned in the report.

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ICICI Securities | Retail Research 10