Tech Mahindra saw a gradual revival in Q2, but will this continue?

Earnings before interest and tax (Ebit) margin was up 110 basis points (bps) sequentially to 9.6%, ahead of the Street’s 9.2% estimate. Currency tailwinds and savings from the Fortius project buoyed margin. Against this backdrop, the stock hit a new 52-week high of ₹1,761.85 on Monday.

Under the new leadership, Tech Mahindra is taking steps to boost its earnings performance, including a slew of cost optimisation measures and mining of existing accounts to garner more revenue from the BFSI vertical. The goal of this three-year turnaround plan, unveiled in April, is above-peer-average revenue growth and significant margin improvement by FY27.

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Tech Mahindra stock is up 36% so far this financial year, marginally ahead of the Nifty IT index. This sharp run-up indicates that investors are acknowledging the company’s efforts to meet these targets. But potential near-term headwinds could weigh on its turnaround journey.

“We believe Tech Mahindra’s phase 1 transformation is progressing well, with Ebit margins likely to exceed 12.7% by FY26,” said a Motilal Oswal Financial Services report on 20 October. However, the period from FY26 to FY27 may bring renewed margin pressures across the industry, including rising attrition rates, high costs associated with backfilling roles, and increasing demand for specialised talent, it cautioned. This could jeopardise Tech Mahindra’s target of 15% Ebit margin in FY27.

US telecom spending remains dull

Secondly, Tech Mahindra’s communications vertical, which brings in 33% of revenue, saw sequential growth after muted performance in several recent quarters, but this growth was driven by Europe and Asia-Pacific (APAC) markets. Telecom clients in the US haven’t seen a meaningful uptick in capital expenditure due to elevated interest rates and these clients continue to prioritise cost savings. A delayed revival in telecom clients’ IT spending could be a dampener. Higher exposure to the troubled telecom vertical has kept Tech Mahindra’s recent earnings performance on the backfoot compared to peers who are more focussed on the BFSI segment.

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Further, the total contract value (TCV) of new deal wins improved sequentially at $603 million in Q2FY25, but was lower year-on-year. The deal pipeline is broadening every quarter and the conversion rate is improving, management said. Note that Tech Mahindra continues to prioritise margin over growth in the near term, and is therefore selectively participating in large deals. 

That said, the macro environment was soft in Q2FY25, as in Q1FY25, management said. Like many of its peers, Tech Mahindra expects a seasonally weak Q3FY25 with furloughs being the same as last year. Also, the company plans to finalise wage hikes over the next few months.

Given this, the stock’s valuation is expensive, trading at 26 times estimated FY26 earnings, shows Bloomberg data. This is in-line with larger tier-1 competitors Tata Consultancy Services Ltd and Infosys Ltd. Tech Mahindra has been able to drive progressive margin improvement by capitalising on low-hanging fruit, but a sustained improvement in both growth and margins will be challenging, given the tough macro environment, said an IIFL Securities Ltd report on 21 October. The brokerage believes turnaround could take longer than the Street anticipates, and rich valuations are already pricing in a recovery with little room for error.

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