2QFY2017 Result Update | IT

November 2, 2016

Tech Mahindra

BUY

CMP

`434

Performance Highlights

Target Price

`600

(` cr)

2QFY17 1QFY17

% chg (QoQ) 2QFY16

% chg (YoY)

Investment Period

12 Months

Net revenue

7,167

6,921

3.6

6,294

13.9

EBITDA

1,070

1,029

4.0

935

14.4

Stock Info

EBITDA margin (%)

14.9

14.6

(22)bps

14.9

(21)bps

Sector

Adj. PAT

645

750

(14.0)

676

(4.6)

Market Cap (` cr)

42,141

Source: Company, Angel Research;

Net Debt (` cr)

(6,370)

Tech Mahindra is expected to post sales of US$107mn (vs. US$106mn expected),

Beta

0.9

registering a qoq growth of 4.0%. In Constant Currency (CC) terms, the company

52 Week High / Low

569/405

posted a qoq growth of 5.0%. The EBIDTA margin came in at 14.9% (vs. 14.6%

Avg. Daily Volume

219,894

expected vs. 14.6% in 1QFY2017). Margins adjusting for one-time restricting

Face Value (`)

expenses came in at 16.1%, an expansion of 120bps. Consequently, the PAT

BSE Sensex

27,877

came in at `645cr (vs. `755cr expected vs. `750cr in 1QFY2017), a decline of

Nifty

7,502

14.0% qoq. We maintain our Buy rating on the stock.

Reuters Code

TEML.BO

Bloomberg Code

TECHM@IN

Result highlights: Tech Mahindra is expected to post sales of US$107mn (vs.

US$106mn expected), registering a qoq growth of 4.0%. In Constant Currency

(CC) terms, the company posted a qoq growth of 5.0%. In INR terms, the

Shareholding Pattern (%)

company posted net revenue of `7,167cr (vs. `7,068cr expected vs. `6,921cr in

Promoters

36.3

1QFY2017), a qoq growth of 3.6%. In terms of geography, Europe was the key

MF / Banks / Indian Fls

12.4

driver contributing about 29.7% of sales in 2QFY2017 (vs. 28.3% in 1QFY2017)

FII / NRIs / OCBs

40.1

and in terms of Industry, Manufacturing contributing about 19.2% of sales in

Indian Public / Others

11.2

2QFY2017 (vs. 18.1% in 1QFY2017). The EBIDTA margin came in at 14.9% (vs.

14.6% expected vs. 14.6% in 1QFY2017). Margins adjusting for one-time

restricting expenses came in at 16.1%, an expansion of 120bps. Consequently,

Abs.(%)

3m 1yr

3yr

the PAT came in at `645cr (vs. `755cr expected vs. `750cr in 1QFY2017), a

Sensex

(0.5)

4.6

31.5

decline of 14.0% qoq.

Tech Mahindra

(11.5)

(19.6)

13.7

Outlook and valuation: We expect a CAGR of 10.6% and 11.5% in USD and

INR revenue, respectively, over FY2016-18E. The PAT is expected to grow at a

3-year price chart

CAGR of 11.4% over FY2016-18E. We maintain our Buy rating on the stock.

800

700

Key financials (Consolidated, Indian GAAP)

600

Y/E March (` cr)

FY2015

FY2016

FY2017E

FY2018E

500

Net sales

22,621

26,494

29,673

32,937

400

300

% chg

20.1

17.1

12.0

11.0

200

Net profit

2,628

3,118

3,173

3,866

100

% chg

(10.4)

18.7

1.8

21.9

EBITDA margin (%)

18.4

16.3

15.5

17.0

EPS (`)

27.1

32.2

32.8

39.9

P/E (x)

16.0

13.5

13.2

10.9

Source: Company, Angel Research

P/BV (x)

3.4

2.9

2.6

2.2

RoE (%)

21.5

21.7

19.6

20.7

RoCE (%)

24.0

20.8

19.8

21.7

Sarabjit kour Nangra

EV/Sales (x)

1.8

1.4

1.2

1.0

+91 22 3935 7800 Ext: 6806

EV/EBITDA (x)

9.7

8.7

7.9

6.1

[email protected]

Source: Company, Angel Research; Note: CMP as of November 1, 2016

Please refer to important disclosures at the end of this report

Tech Mahindra | 2QFY2017 Result Update

Exhibit 1: 2QFY2017 performance (Consolidated, Indian GAAP)

(` cr)

2QFY17

1QFY17

% chg (qoq)

2QFY16

% chg (yoy)

1HFY17 1HFY16

% chg (yoy)

Net revenue

7,167

6,921

3.6

6,616

8.3

14,088

12,909

9.1

Cost of revenue

4,972

4,881

1.9

4,500

10.5

9,852

8,944

10.2

Gross profit

2,196

2,040

7.6

2,116

3.8

4,236

3,965

6.8

SG&A expense

1,126

1,011

11.3

1,029

9.4

2,137

1,974

8.3

EBITDA

1,070

1,029

4.0

1,087

(1.5)

2,099

1,991

5.4

Dep. and amortization

245

202

21.2

197

24.2

447

369

21.1

EBIT

825

827

(0.2)

890

(8.6)

1,653

1,622

1.9

Interest

25.9

97.0

58.7

Other income

139

246

(43.6)

42.1

385

222

73.1

PBT

930

1,046

(11.1)

970

(5.5)

1,975

1,806

9.4

Income taxes

286

247

15.9

191

50.1

533

405

31.6

PAT

644

799

(19.4)

779

(18.9)

1,442

1,401

3.0

Minority interest

(46)

(65.8)

(3)

PAT after minority interest

645

752

(14.3)

776

(16.9)

1,442

1,403

2.8

Profit from associates

(2)

Exceptional item

Reported PAT

645

750

(14.0)

776

(16.9)

1,440

1,403

2.6

Adj. PAT

645

750

(14.0)

776

(16.9)

1,440

1,403

2.6

Diluted EPS

6.7

7.9

(14.5)

8.1

(16.9)

15.0

14.6

2.6

Gross margin (%)

30.6

29.3

138bp

32.0

(135)bps

30.1

30.7

(63)bp

EBITDA margin (%)

14.9

14.6

28bp

16.4

(150)bps

14.9

15.4

(87)bp

EBIT margin (%)

11.5

11.7

(23)bp

13.4

(193)bps

11.7

12.6

(117)bp

PAT margin (%)

9.0

10.7

(168)bps

11.7

(273)bps

10.2

10.9

(110)bp

Source: Company, Angel Research

Exhibit 2: 2QFY2017 - Actual Vs Angel estimates

(` cr)

Actual

Estimate

% Var

Net revenue

7,167

7,068

1.4

EBITDA margin (%)

14.9

14.6

28bps

PAT

645

755

(14.5)

Source: Company, Angel Research

Revenue growth led by Europe

For 2QFY2017, the company posted sales of `7,167cr (vs. `7,068cr expected and

vs. `6,921cr in 1QFY2017), a qoq growth of 3.6%. In US$ terms, the revenue

posted sales of US$107mn (vs. US$106mn expected), registering a qoq growth of

4.0%. In Constant Currency (CC) terms, the company posted a qoq growth of

5.0%. Organic revenue growth was at 2.5% qoq and the contribution from

acquisitions tune to 2.5%.

The top-line growth was driven by Europe, which was 29.7% of sales (vs. 28.3% in

1QFY2017); while ROW was a drag constituting

~22.0% (vs.

22.8% in

1QFY2017). Both these geographies posted qoq growth of 9.1% and 0.3%,

respectively. USA, on other hand had contributed around ~48.3% (vs. ~49.0% in

1QFY2017), registering a qoq growth of 2.5%.

In terms of industries, Manufacturing and BFSI were the key drivers of top-line,

registering a qoq growth of

10.3% and

5.8%, respectively. Manufacturing

constituted ~19.2% of sales (vs. 18.1% in 1QFY2017), while BFSI contributed

~11.5% of sales (vs. 11.3% of sales in 1QFY2017). Retail, Transport and Logistics

November 2, 2016

Tech Mahindra | 2QFY2017 Result Update

contributed ~6.8% of sales (vs. 6.5% of sales in 1QFY2017), registering a qoq

growth of 8.8%. Communication, on the other hand, contributed ~48.4% of sales

(vs. 49.4% of sales in 1QFY2017), registering a qoq growth of 2.3%.

Exhibit 3: Trend in revenue growth

1080.0

1,072

9.0%

1070.0

8.0%

1060.0

7.0%

1050.0

6.0%

1040.0

1,032

5.0%

1030.0

1,023

4.0%

1020.0

1,015

1,011

3.0%

1010.0

2.2%

2.0%

1000.0

0.8%

0.9%

1.0%

990.0

0.4%

980.0

0.0%

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

Sales ( in US $mn)

qoq (%)

Source: Company, Angel Research

Exhibit 4: Growth in industry segments

Particulars

% to revenue

% growth (QoQ)

% growth (YoY)

Telecom

48.4

2.3

(3.0)

Manufacturing

19.2

10.3

22.0

TME

7.2

(0.2)

(6..9)

BFSI

11.5

5.8

27.1

RTL

6.8

8.8

20.2

Others

6.8

(3.2)

9.3

Source: Company, Angel Research

In terms of geographies, ROW posted a growth of 0.3% qoq, while Europe and US

posted a growth of 9.1% and 2.5% qoq, respectively.

Exhibit 5: Growth trend in geographies

Particulars

% to revenue

% growth (QoQ)

% growth (YoY)

Americas

48.3

2.5

4.8

Europe

29.7

9.1

7.5

RoW

22.0

0.3

6.6

Source: Company, Angel Research

November 2, 2016

Tech Mahindra | 2QFY2017 Result Update

Hiring and client metrics

During the quarter, the company reported a net addition of 5,670 employees,

taking its overall headcount to 1,12,886. The BPO headcount currently stands at

27, 669 and was the only division to witness additions. Attrition (on LTM basis) was

at 19%.

Exhibit 6: Employee metrics

Particulars

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

Software professionals

71,657

71,892

72,125

73,590

78,404

BPO professionals

26,513

28,279

27,254

27,326

27,669

Sales & support

7,065

6,966

6,053

6,300

6,813

Total employees

1,05,235

1,07,137

105,432

107,216

112,886

Attritions (%)

Source: Company, Angel Research

Exhibit 7: Trend in utilization rate

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

Source: Company, Angel Research

The company added 7 new clients during the quarter, taking the active client base

to 825 (vs. 818 in 1QFY2017), with 4 clients added in US$10mn-20mn+ bracket

and other additions mainly in the US$5mn-10mn+ bracket.

Exhibit 8: Client metrics

Particulars

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

Total active clients

767

801

807

818

825

US$1mn-5mn

195

221

207

197

221

US$5mn-10mn

US$10mn-20mn

US$20mn-50mn

US$50mn+

Source: Company, Angel Research

November 2, 2016

Tech Mahindra | 2QFY2017 Result Update

Operating margin expands

On the operating front, the EBDITA margin came in at 14.9%, a qoq expansion of

28bps. The EBIT margin came in at 11.5% (vs. 11.7% in 1QFY2017), while it was

down qoq 23bps. However, adjusting for onetime restructuring expenses the

EBDITA margin was 16.4%.

Exhibit 9: Margin trend (%)

35.3

32.0

31.3

30.6

29.5

16.6

16.9

16.7

14.9

13.7

14.4

13.6

12.0

11.5

2QFY16

3QFY16

4QFY16

1QFY17

2QFY17

Gross margin

EBITDA margin

EBIT margin

Source: Company, Angel Research

Investment arguments

Growth prospects decent; Brexit - a near term concern: The Management is more

optimistic about the Communications vertical (excluding LCC, where a lot of

portfolio rationalization has taken place). In the near term, the Management feels

Brexit could cause temporary instability and uncertainty; however it is too early to

call out any immediate business implications. We expect a CAGR of 10.6% and

11.5% in USD and INR revenue, respectively, over FY2016-18E.

Deal pipeline healthy: Tech Mahindra remains confident of improving revenue

growth, citing healthy deal pipeline along with pick up in discretionary spending,

primarily in the US. The Management sounded confident of demand from BFSI,

Healthcare, Manufacturing and Retail. Tech Mahindra is following a two-pronged

strategy to expand its enterprise business i.e., providing end-to-end offerings in

leadership areas like manufacturing and following a niche offerings-led entry

strategy in areas like BFSI, where it is a challenger. Better cross-sell of services can

help grow marquee accounts post the recent acquisitions. We expect the enterprise

segment growth to be led by broader revival in the markets and deepening of

existing relationships. During 2QFY2017 the company won deals worth TCV of

US$325mn. The pipeline has been healthy and most of the deals won are in

newer areas like product engineering, cloud, IoT and IMS.

Inorganic growth initiatives to augment well for company: The company has been

active in the M&A space, with it having acquired Satyam a few years back, to

acquiring LCC and Softgen recently. Softgen’s and LCC’s acquisition was

consolidated in 4QFY2015. LCC is one of the world’s largest independent global

providers of network engineering services to the telecommunications industry with

an estimated annual revenues of more than US$400mn (CY2014), with workforce

November 2, 2016

Tech Mahindra | 2QFY2017 Result Update

of over 5,700 network professionals across five continents and more than 50

countries. With this acquisition, Tech Mahindra will also be addressing a rapidly

growing market opportunity as telecommunications companies and enterprises

accelerate their network upgrade cycle.

Outlook and valuation

Given the recent acquisitions and healthy order pipeline, the company is expected

to post a healthy US$ and INR CAGR of 10.6% and 11.5%, respectively, over

FY2016-18E. However, the acquisition of LCC will be margin dilutive in the near

term, leading the FY2016 EBDIT margin to drop to 16.3% from 22.2% in FY2014.

The company, given its success in turnaround of its earlier acquisition - Satyam,

believes it would be able to do the same with the recent acquisitions and would be

able to get close to achieving the 20% EBIT levels in future. Given the conducive

valuation on EV/sales front, where it trades at a significant discount to its peers, we

believe the stock should witness uptrend once the profitability returns to its mean

average. We recommend a Buy rating on the stock.

Exhibit 10: Key assumptions

FY2017E

FY2018E

Revenue growth (US$)

10.3

11.0

USD-INR rate (realized)

66.0

Revenue growth (`)

12.0

11.0

EBITDA margin (%)

15.5

17.0

Tax rate (%)

23.4

EPS growth (%)

1.8

21.9

Source: Company, Angel Research

Exhibit 11: One-year forward PE (x)

800

600

400

200

Nov-08 Sep-09 Jun-10 Apr-11 Jan-12 Nov-12 Aug-13 Jun-14 Mar-15 Jan-16 Oct-16

Price

20x

17x

14x

11x

Source: Company, Angel Research. Note: P/E includes profits of Mahindra Satyam from FY2012

November 2, 2016

Tech Mahindra | 2QFY2017 Result Update

Exhibit 12: Recommendation summary

Company

Reco

CMP Tgt Price Upside

FY2018E FY2018E

FY2016-18E

FY2018E FY2018E

(`)

(%)

EBITDA (%)

P/E (x)

EPS CAGR (%)

EV/Sales (x)

RoE (%)

HCL Tech

Buy

773

1,000

29.4

20.5

12.1

9.6

1.7

17.9

Infosys

Buy

989

1,249

26.3

27.0

14.2

8.4

2.4

21.6

TCS

Accumulate

2,348

2,620

11.6

27.6

16.1

8.5

3.2

33.1

Tech Mahindra

Buy

434

600

38.9

17.0

10.9

11.4

0.9

20.7

Wipro

Buy

461

590

28.0

18.1

11.6

5.3

1.6

19.3

Source: Company, Angel Research.

Company Background

Tech Mahindra was founded in 1986 as a joint venture between Mahindra Group

and British Telecom (BT) to service the latter. Later on, the company started

servicing other external clients as well (solely in the telecom industry).In June 2009,

Tech Mahindra acquired a 42.7% stake in erstwhile Satyam Computers (now

Mahindra Satyam) and now the latter is entirely merged with the company.

The company has recently acquired the companies - LCC and Softgen. These two

acquisitions have been consolidated in 4QFY2015. LCC is one of the world’s

largest independent global providers of network engineering services to the

telecommunications industry. LCC is estimated to have annual revenues of more

than US$400mn (CY2014), with workforce of over 5,700 network professionals

across five continents and more than 50 countries.

November 2, 2016

Tech Mahindra | 2QFY2017 Result Update

Profit and loss statement (Consolidated, Indian GAAP)

Y/E March (` cr)

FY2014 FY2015 FY2016 FY2017E FY2018E

Net sales

18,831

22,621

26,494

29,673

32,937

Cost of revenues

12,427

15,920

18,323

20,177

22,068

Gross profit

6,404

6,701

8,172

9,495

10,869

% of net sales

34.0

29.6

30.8

32.0

33.0

SG&A expenses

2,220

2,549

3,853

4,896

5,270

% of net sales

11.8

11.3

14.5

16.5

16.0

EBITDA

4,184

4,153

4,318

4,599

5,599

% of net sales

22.2

18.4

16.3

15.5

17.0

Depreciation and amortization

522

611

762

861

955

% of net sales

2.8

2.7

2.9

EBIT

3,662

3,541

3,556

3,739

4,644

% of net sales

19.4

15.7

13.4

12.6

14.1

Interest expense

Other inc., net of forex gain/(loss)

233

106

557

Profit before tax

3,815

3,618

4,017

4,199

5,105

Provision for tax

752

960

860

983

1,194

% of PBT

19.7

26.5

21.4

23.4

PAT

3,063

2,659

3,157

3,217

3,910

Exceptional item

Minority interest

Reported PAT

3,029

2,628

3,118

3,173

3,866

Adjusted PAT

2,933

2,628

3,118

3,173

3,866

Fully diluted EPS (`)

30.3

27.1

32.2

32.8

39.9

November 2, 2016

Tech Mahindra | 2QFY2017 Result Update

Balance sheet (Consolidated, Indian GAAP)

Y/E March (` cr)

FY2014

FY2015

FY2016

FY2017E

FY2018E

Equity capital

234

480

484

Preference capital

Share premium

Profit and loss

8,947

11,768

13,882

15,696

18,204

Other reserves

Net worth

9,182

12,249

14,367

16,181

18,688

Secured loans

309

621

806

Unsecured loans

Total debt

363

675

859

860

861

Other long term liability

376

377

Long-term provisions

414

415

Minority interest

144

160

203

145

Amount pending investigation

1,230

895

Total capital employed

11,709

14,768

17,114

18,872

21,380

Gross block

5,460

7,811

8,811

9,811

10,811

Accumulated dep.

(2,866)

(3,477)

(4,239)

(5,099)

(6,055)

Net block

2,594

4,334

4,572

4,712

4,757

Capital WIP

266

267

268

Total fixed assets

2,861

4,601

4,839

4,979

5,025

Investments

2,103

Long term loans and adv.

914

1,306

1,502

1,727

1,986

Interest in TML benefit trust

Deferred tax asset, net

383

390

Other non-current assets

Inventories

Sundry debtors

4,349

5,206

5,987

6,896

7,980

Cash and cash equv.

4,756

2,405

5,127

6,486

8,612

Loans and advances

2,616

3,813

2,998

2,999

Current investments

Unbilled revenue

Sundry creditors

(1,549)

(1,654)

(1,903)

(2,188)

(2,516)

Other liabilities

(1,415)

(1,627)

(1,871)

(2,152)

(2,474)

Provision

(1,267)

(1,799)

(2,068)

(2,379)

(2,736)

Working capital

7,500

6,368

8,280

9,673

11,876

Total capital deployed

11,709

14,768

17,114

18,872

21,380

November 2, 2016

Tech Mahindra | 2QFY2017 Result Update

Cash flow statement (Consolidated, Indian GAAP)

Y/E March (` cr)

FY2014

FY2015

FY2016

FY2017E

FY2018E

Pre tax profit from operations

3,063

2,659

3,157

3,217

3,910

Depreciation

522

611

762

861

955

Exp. (deffered)/written off/others

Pre tax cash from operations

3,585

3,270

3,919

4,077

4,865

Other income/prior period ad

233

106

557

Net cash from operations

3,818

3,376

4,475

4,634

5,422

Tax

(752)

(960)

(860)

(983)

(1,194)

Cash profits

3,066

2,417

3,615

3,651

4,227

Sundry Debtors

Inventories

(980)

(857)

(781)

(909)

(1,085)

Loans and advances

(15)

Sundry creditors

(1,324)

(1,197)

815

(1)

Others

692

105

248

285

328

Net trade working capital

(623)

212

244

281

323

Cashflow from operating activities

(2,233)

(1,752)

540

(344)

(434)

(Inc)/dec in fixed assets

832

665

4,155

3,307

3,794

(Inc)/dec in investments

(369)

(1,740)

(238)

(140)

(46)

(Inc)/dec in other non current assets

(2,067)

Cashflow from investing activities

104

Inc/(dec) in debt

(265)

(3,791)

(238)

(140)

(46)

Inc/(dec) in deferred revenue

490

(311)

(185)

(1)

Inc/(dec) in equity/premium

Inc/(dec) in minority interest

(2)

Addition to reser. on amalgamation

(9)

(16)

(43)

Dividends

Others

(231)

(679)

(1,359)

Cashflow from financing activities

479

1,781

392

(507)

(343)

Cash generated/(utilised)

726

775

(1,195)

(1,808)

(1,702)

Cash at start of the year

1,294

(2,351)

2,722

1,359

2,046

Cash at end of the year

3,463

4,756

2,405

5,127

6,308

November 2, 2016

Tech Mahindra | 2QFY2017 Result Update

Key Ratios

Y/E March

FY2014

FY2015

FY2016

FY2017E

FY2018E

Valuation ratio (x)

P/E (on FDEPS)

14.3

16.0

13.5

13.2

10.9

P/CEPS

11.8

13.0

10.8

10.4

8.7

P/BVPS

4.6

3.4

2.9

2.6

2.2

Dividend yield (%)

1.2

2.8

1.4

1.6

EV/Sales

2.0

1.8

1.4

1.2

1.0

EV/EBITDA

8.9

9.7

8.7

7.9

6.1

EV/Total assets

13.1

8.7

7.8

7.3

6.8

Per share data (`)

EPS

30.3

27.1

32.2

32.8

39.9

Cash EPS

36.7

33.5

40.1

41.7

49.8

Dividend

5.0

12.0

6.0

7.0

Book value

94.9

126.6

148.4

167.2

193.1

Dupont analysis

Tax retention ratio (PAT/PBT)

0.8

0.7

0.8

Cost of debt (PBT/EBIT)

1.0

1.1

EBIT margin (EBIT/Sales)

0.2

0.1

Asset turnover ratio (Sales/Assets)

6.6

4.9

5.5

6.0

6.6

Leverage ratio (Assets/Equity)

0.3

0.4

0.3

Operating ROE (%)

33.0

21.5

21.7

19.6

20.7

Return ratios (%)

RoCE (pre-tax)

31.3

24.0

20.8

19.8

21.7

Angel RoIC

54.8

29.3

30.3

30.8

37.2

RoE

31.9

21.5

21.7

19.6

20.7

Turnover ratios( x)

Asset turnover (fixed assets)

6.6

4.9

5.5

6.0

6.6

Receivables days

Payable days

November 2, 2016

Tech Mahindra | 2QFY2017 Result Update

Research Team Tel: 022 - 39357800

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Tech Mahindra

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Ratings (Based on expected returns

Buy (> 15%)

Accumulate (5% to 15%)

Neutral (-5 to 5%)

over 12 months investment period):

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Sell (< -15)

November 2, 2016