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Tech Mahindra (TECMAH) | 529 Target : | 570 Target Period : 12 Months Potential Upside : 16% Core Communication – on Path to Recovery

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Tech Mahindra (TECMAH) | 529 Target : | 570 Target Period : 12 Months Potential Upside : 16% Core Communication – on Path to Recovery Result Update August 2, 2016 Rating matrix Rating : Buy Tech Mahindra (TECMAH) | 529 Target : | 570 Target Period : 12 months Potential Upside : 16% Core communication – on path to recovery... What’s changed? • Tech Mahindra (TechM) reported Q1FY17 earnings, which were Target Changed from | 600 to | 570 largely in line with our estimates EPS FY17E Changed from | 36 to | 34 EPS FY18E Changed from | 40 to | 38.1 • US$ revenues grew 0.9% QoQ to $1,031.5 million, largely in line with Rating Unchanged our 1% growth and $1,033 million estimate. In constant currency, revenues grew 0.4% QoQ Quarterly performance • Rupee revenues grew 0.5% QoQ to | 6,921 crore and were above Q1FY17 Q1FY16 YoY (%) Q4FY16 QoQ (%) our 0.3% QoQ growth and | 6,907 crore estimate Revenue 6,921 6,294 10.0 6,884 0.5 • At 14.9%, EBITDA margins declined 200 bps QoQ and were below EBITDA 1,029 907 13.5 1,153 (10.7) our 15.7% and 120 bps decline estimate led by higher visa fees EBITDA (%) 14.9 14.4 48 bps 16.7 -180 bps (down 100 bps) and seasonality of Comviva (down 170 bps) PAT 750 624 20.2 860 (12.8) • Reported PAT of | 750.1 crore was marginally above our | 731 crore Key financials estimate despite lower-than-expected EBITDA margin mainly due to | Crore FY15 FY16 FY17E FY18E higher other income (| 246 crore vs. | 166 crore in Q4FY16) Net Sales 22,621 26,494 29,256 32,710 Core communication reports marked improvement… EBITDA 4,192 4,277 4,740 5,397 TechM’s revenues grew 0.9% in dollar terms and 0.4% in constant Net Profit 2,628 3,073 3,265 3,660 currency terms. The enterprise division reported strong 4.2% sequential EPS (|) 26.7 34.5 34.0 38.1 growth partly supported by the Pinanfarina acquisition ($9 million for a Valuation summary month). Growth in the enterprise division was led by BFSI (11.3% of FY15 FY16 FY17E FY18E revenues, up 7.5% QoQ in $ terms) and retail, transport & logistics (6.5% P/E 18.3 14.2 14.4 12.9 of revenues, up 5.8% QoQ in $ terms). The key highlight for Q1FY17 was Target P/E 21.3 16.5 16.8 15.0 a marked improvement in core communication. Core communication EV / EBITDA 10.9 10.7 9.4 8.0 grew 3.5-4% sequentially after adjusting for LCC & Comviva acquisitions P/BV 3.9 3.3 3.1 2.7 following a sharp improvement in Top five client’s revenues after a muted RoNW (%) 21.5 23.1 21.4 20.9 performance for six consecutive. Revenues from Top five clients grew RoCE (%) 27.2 27.7 27.5 26.9 4.1% sequentially to $297.1 mn. The management also highlighted that momentum is coming back in core communication division. Furthermore, Stock data the deal pipeline remains strong at $300 mn. Overall, we expect TechM’s Particular Amount Market Capitalization (| Crore) 48,152.5 $ revenues to grow 8.2%, 11% to $4367 mn, $4846 mn in FY17, FY18E, Total Debt (| Crore) 1,350.4 respectively. Cash and Investments (| Crore) 5,747.2 Margin to remain flat in FY17E… EV (| Crore) 43,091.9 At 14.9%, EBITDA margins declined 200 bps QoQ and were below our 52 week H/L 582 / 408 15.7% and 120 bps decline estimate led by higher visa fees (down 100 Equity capital 960.8 Face value | 5 bps) and more pronounced seasonality in Comviva acquisition (down 170 bps). In Q2FY17, there could be cross currency headwind, which would Price performance impact EBITDA margin by 40-50 bps. The management now expects 1M 3M 6M 12M margins to remain flat at FY16 level vs. earlier anticipation of TechMahindra (3.0) (8.3) (13.9) (25.4) improvement in margins trajectory. Going ahead, we build in EBITDA MindTree 7.6 (1.9) (0.5) 13.9 margin of 16.2%, 16.5% in FY17E, FY18E, respectively. KPIT Tech 5.2 8.3 27.8 (0.6) Core communication picking up; reiterate BUY… NIIT Tech (0.2) 3.6 (0.5) 32.4 We believe TechM is on the path to recovery in its core communication Research Analysts segment with a marked improvement in its top five client’s revenues after Deepak Purswani, CFA a muted performance for six consecutive quarters. Furthermore, the [email protected] enterprise division also showed strong growth (partly due to acquisitions). We expect TechM to report rupee revenue, PAT CAGR of Tushar Wavhal 11.1%, 9.1% in FY16-18E (average 16.4% EBITDA margins in FY17-18E), [email protected] vs. 40.5%, 36.9% reported in FY11-16 (average 19.3%), respectively, driven by enterprise business, a gradual pick-up in communication Deepti Tayal business, order bookings and large deal ramp-ups. We value TechM at [email protected] 15x its FY18E EPS of | 38.1 to arrive at our | 570 target price. We maintain our BUY recommendation. ICICI Securities Ltd | Retail Equity Research Variance analysis Q1FY17 Q1FY17E Q1FY16 YoY (%) Q4FY16 QoQ (%) Comments Revenue 6,920.9 6,906.5 6,293.8 10.0 6,883.7 0.5 Revenue growth was led by enterprise business Employee expenses 4,880.7 4,869.1 4,441.5 9.9 4,778.8 2.1 Gross Margin 2,040.2 2,037.4 1,852.3 10.1 2,104.9 -3.1 Gross margin (%) 29.5 29.5 29.4 5 bps 30.6 -110 bps SG&A expenses 1,011.2 953.1 945.8 6.9 952.0 6.2 EBITDA 1,029.0 1,084.3 906.5 13.5 1,152.9 -10.7 EBITDA margin decline was led by seasonality of Comviva and higher visa EBITDA Margin (%) 14.9 15.7 14.4 48 bps 16.7 -180 bps fees Depreciation & amortisation 201.9 221.0 172.4 17.1 217.4 -7.1 EBIT 827.2 863.3 734.1 12.7 935.5 -11.6 EBIT Margin (%) 12.0 12.5 11.7 29 bps 13.6 -164 bps Other income (less interest) 218.4 107.0 103.0 112.0 126.3 72.9 PBT 1,045.6 970.3 837.1 24.9 1,061.8 -1.5 Tax paid 246.8 230.0 214.2 15.2 180.6 36.7 PAT 750.0 731.3 624.1 20.2 860.0 -12.8 PAT was ahead of estimates mainly on account of higher other income Key Metrics Closing employees 107,216 107,000 103,673 3.4 105,432 1.7 IT attrition (%) 21.0 20.0 19.0 200 bps 21.0 0 bps Utilisation incl trainees (%) 78.0 78.5 74.0 400 bps 77.0 100 bps Average $/| 67.0 66.9 63.6 5.4 67.5 -0.7 Source: Company, ICICIdirect.com Research Change in estimates FY17E FY18E (| Crore) Old New % Change Old New % Change Comments Revenue 29,866 29,256 -2.0 33,059 32,710 -1.1 EBITDA 5,007 4,740 -5.3 5,538 5,397 -2.5 EBITDA Margin (%) 16.8 16.2 -56 bps 16.8 16.5 -24 bps PAT 3,456 3,265 -5.5 3,839 3,660 -4.7 EPS (|) 36.0 34.0 -5.6 40.0 38.1 -4.7 We have fine-tuned our estimates to reflect the Q1FY17 performance Source: Company, ICICIdirect.com Research Assumptions Current Earlier Comments FY15 FY16E FY17E FY18E FY17E FY18E Closing employees 103,281 105,432 112,454 118,212 110,499 118,212 IT attrition (%) 18.0 20.0 18.0 18.0 18.0 18.0 Utilisation incl trainees (%) 75.8 78.5 76.0 77.8 79.0 79.0 Average $/| 67.3 65.6 67.0 67.5 66.0 67.0 We have revised our $/| assumption Source: Company, ICICIdirect.com Research ICICI Securities Ltd | Retail Equity Research Page 2 Company Analysis Key highlights from earnings call… The management expects FY17E margins to be at the same levels as FY16 mainly due to the cross currency impact post Brexit. The company highlighted that margins of the Comviva business are expected to improve with improved sales from Q2FY17 onwards while no great improvement may be seen in Q2 in the LCC acquisition. The company completed the acquisition of Pininfarina on May 30, 2016 and expects a full quarter run rate between $18 million and $20 million. Also, the company closed the BIO Agency acquisition in the first week of July 2016. It is getting consolidated in Q2FY17 financials. According to the management, although the negative growth in telecom is on account of network services and on account of mobility business, the company expects the network tech business to continue to see more transactions and more spend happening in the long term. Core Communication showing signs of improvement… TechM reported steady Q1 earnings with 0.9% $ revenue growth and 0.4% in CC terms. Enterprise business grew 4.2% QoQ where growth was led by BFSI (11.3% of revenues, grew 7.5% QoQ growth in $ terms). Manufacturing (18% of revenues, grew 6.8% QoQ growth) and retail, transport & logistics (6.5% of revenues, grew 5.8% QoQ growth. However, the key highlight for Q1FY17 was marked by improvement in Core Communication. The Core Communication grew 3.5%-4% sequentially after adjusting for LCC & Comviva acquisitions following sharp improvement in top 5 clients revenues after muted performance for six consecutive quarters.
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