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Tech Mahindra: good volume growth in March quarter

LiveMint logoLiveMint 14-05-2014 R. Sree Ram

Investors will be pleased by Tech Mahindra Ltd’s January-March quarter performance. The company has beaten revenue growth estimates by a handsome margin. Against the December quarter, US dollar revenue rose 4.3% to $825 million. This is the third consecutive quarter the company has reported a sequential growth of more than 4%, easily beating estimates.

The revenue growth is better than its peers. Industry leader Tata Consultancy Services Ltd (TCS) managed a growth of 1.9%, while Wipro Ltd and HCL Technologies Ltd were able to grow their US dollar revenues by 2.5% and 3%, respectively, in the last quarter.

Even better, Tech Mahindra’s growth is driven by volumes. In a conference call, the management said that volumes increased by 4.6% in the March quarter. Core telecom business led the growth. Its network management services continue to see good demand. The company also executed several short-term projects, which added momentum to revenue. Its focus on mining existing clients is bearing fruit. The revenue contribution of the top 10 clients increased two percentage points to 51% in the last quarter. As the company increased its service offerings, clients who bill more than $10 million increased by five to 52. In the previous three quarters, the number was at 46-48.

As expected, wage hikes pushed up employee costs. Cost of services as a percentage of revenue increased 280 basis points to 64%. Add to this the impact of adverse currency movement, discontinuation of restructuring fees and transitioning costs, and the upshot was that Ebitda margins softened 190 basis points to 21.3%. But then, many were expecting the margins to soften at a sharper pace of around 250 basis points. Ebitda is short for earnings before interest, taxes, depreciation and amortization. A basis point is one- hundredth of a percentage point.

Moreover, the management commentary is encouraging. They said that the company’s current deal pipeline is 30-40% more than what it was in the year-ago period. Even though customer information technology budgets are not yet seeing a significant rise, Tech Mahindra’s client engagement activities and new service offerings are helping it bill more. With the focus continuing to be on “growing business”, the management expects the operating margins to move around 20%.

While robust revenue growth may impress investors, the stock—despite the rally in the past year—is still trading at a discount to its peers like HCL Tech. For the company to reduce the valuation gap, it has to improve cash flows.

According to JP Morgan India Pvt. Ltd, Tech Mahindra’s low cash flow conversion is one reason why investors are not willing to pay higher multiples for the stock. “Tech Mahindra converts just 10% of its revenues into OCF (operating cash flow) versus 20%+ for Infosys & HCL Tech and 19% for TCS. Similarly, TechM’s FCF (free cash flow) conversion is also rather modest compared to peers. This is a worrying point for some investors and represents a tangible improvement area for the company,” JP Morgan said in a recent note

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