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Strong execution key for Tech Mahindra to achieve 3-year targets

May 06, 2024 15:34 IST

The market could not make a clear assessment of Tech Mahindra with the stock swinging wildly in the last two sessions.

Tech Mahindra

Photograph: Dado Ruvic/Reuters

The results on Thursday were expected to be weak but the stock dropped slightly.

However, investors reviewed the three-year turnaround plan and decided the stock had been oversold and the price recovered 7.5 per cent.

Net-net, the stock is up 7.7 per cent in the recent sessions.

Tech Mahindra reported Q4FY24 revenue of $1.48 billion, down 0.8 per cent (at constant currency).

 

The Communications Media & Entertainment vertical was weak and declined 2.8 per cent quarter-on-quarter (Q-o-Q).

Enterprise growth was mixed, with retail declining 9.6 per cent Q-o-Q and Banking, Financial Services and Insurance (BFSI) growing well at 3.5 per cent Q-o-Q.

The adjusted operating profit margin was at 7.4 per cent.

Net headcount declined by 795 Q-o-Q to 145,450.

The reported net profit was down 50 per cent Y-o-Y.

Total contract value stood at $500 million which is down 15 per cent year-on-year (Y-o-Y) but up 30 per cent Q-o-Q.

The management announced its vision for FY25-27, with a target of hitting an operating margin of 15 per cent by FY27 along with a 30 per cent return on capital employed and a target of high free cash flow or better by FY27.

The focus will be on scaling large accounts, winning multi-tower deals, driving synergies from past acquisitions, improving cost structure, and achieving profitable growth.

One key target is cost reductions of $250 million every financial year - this will be a margin booster if achieved.

The management hopes to be among the top three IT services companies in terms of margins beyond FY27.

The market obviously thinks the restructuring move is in the right direction (SBU right-sizing, investment in top accounts, vertical delivery teams and employee investments).

But it s a long runway and tangible improvements would be tracked carefully.

While management says growth bottomed in Q4FY24, it will only start to pick up meaningfully in H2FY25.

The company believes that FY25 would still be a turnaround before things stabilise in FY26.

The weak Q4FY24 and tough times in the key communications vertical could be a drag on FY25 revenue.

FY25 top line growth may be low single-digits, before recovery to double-digits in FY26. FY25 and FY26 margins may also be muted.

In FY25, the company intends above normal investments (1.5 per cent of revenue) to build front-end capabilities (sales, large deal teams), accounts, key market and service lines.

Long-term investments prioritise Australia, New Zealand, Japan, Singapore, and Indonesia.

The investments are likely to halve in FY26 and normalise by FY27.

The company will also drive for operational synergies via productivity gains, seeking a higher margin service mix and synergies with acquired entities.

It will focus on generating cash flow and look to return 85 per cent of free cash flow to shareholders, rather than looking at M&A.

If it achieves its targets, earnings could more or less double from reported FY24 levels of Rs 41 to near Rs 80 by FY27 and the Ebit margin would climb to near 15 per cent by FY27.

Execution would be key for this.

The target numbers appear to be accepted as credible by consensus, going by the share price surge.


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Devangshu Datta
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