Portfolio restructuring to boost margins - Tech Mahindra Q2FY23 review

What's Buzzing 

Tech Mahindra's order book continue to be in the guided range of US$700 mn to US$1 billion (bn). Attrition has come down 400 bps in the last two quarters. 

Context 

The company's revenues increased 2.9% QoQ, 16.8% YoY in CC terms (3.4% QoQ, ~18% YoY in CC terms, adjusted for exit of some low margin portfolios). In terms of geographies, revenue growth was aided by 2.8% QoQ growth in the US (51% of mix) while Europe, RoW reported a decline of 3.6%, 0.5% QoQ, respectively, due to currency impact (ex- currency impact, it grew 3.6%, 3.4% in CC terms, respectively). In terms of verticals, growth was aided by Manufacturing, Technology, Retail, which grew 4.9%, 4.5%, 2.9% QoQ respectively, while BFSI, Communication (56% of revenue mix together) reported 1.4%, 2.1 QoQ revenue decline, respectively (+3.1% CC growth for CME and +0.5% CC growth for BFSI). The EBIT margin grew 32 bps QoQ to 11.4%, in CC terms margins were 11.7% (+60 bps on utilisation improvement, +20 bps on low margin portfolio exits, +60 bps on lower SG&A expenses, +50 bps pricing benefit, -120 bps wage hike impact, -30 bps currency impact). TCV for the quarter was at US$716 mn ( -5% YoY, -11% QoQ). The company added 5,877 employees in Q2, taking its total employee base at 163,912. LTM attrition declined 260 bps QoQ to 19.6% (~400 bps decline in the last two quarters). 

Our Perspective 

Q3 revenue is expected to be impacted by furlough. The company indicated a cautious outlook on Europe geography (24% of mix) due to high inflation and energy prices as it expects slower decision making in the region. On the CME vertical, some re-prioritisation of tech spending may happen especially on customer experience and platform building sub-segments but core spending in this vertical continues to be strong. On manufacturing, it continues to focus on wallet share gain across existing customers while growth is expected to continue in the coming quarters. The company will continue its portfolio restructuring in H2 as well especially on those portfolios where scalability is the issue as well as the portfolios where they are unable to raise prices. Pricing, utilisation improvement, moderation of subcontractor costs, portfolio restructuring will be key drivers for margin improvement ahead. TCV is expected to be in the guided range for H2 as well. We estimate revenue, EBITDA, PAT CAGR of 11.6%, 10.4%, 12.1% CAGR, respectively, over FY22-25E.