The December quarter earnings of IT services provider Tech Mahindra Ltd were a beat on many counts. Consolidated net profit at ₹1,310 crore, up 23% quarter-on-quarter (q-o-q), was ahead of Bloomberg’s consensus estimate of ₹1,167.30 crore. Consolidated revenue at ₹9,647 crore, up 2.9% sequentially, also exceeded analysts’ estimate of ₹9,562 crore. In constant currency terms, sequential revenue growth was at 2.8%, largely in-line with expectations.
But the key highlight of its quarterly result was Ebit margin of 15.9%, higher 170 basis points (bps) sequentially. Ebit is short for earnings before interest and tax. One basis point is one hundredth of a percentage point. Ebit margin was much ahead of the 14%-14.5% range that analysts were pencilling-in.
In a post earnings media briefing, its management sai, Ebit margin was aided by a couple of factors. Strong operating leverage, increased offshoring of fixed priced model projects and an all-time high utilisation of 87%, which has added around 80 bps to Ebit margin growth.
It should be noted that on a sequential basis, Tech Mahindra has posted higher margin expansion than some of its Tier-1 peers. For instance, Ebit margin of Tata Consultancy Services Ltd grew by 40bps in Q3FY21. HCL Technology Ltd saw its margin expand by 130bps and for Infosys Ebit margin growth was flat in the December quarter.
Analysts say, while the company’s margin was a positive surprise, investors should take a note of some downside risks. “EBIT margin was a sharp 190 basis point ahead of our 14% estimate. Going ahead for EBIT margin, salary inflation, return of travel cost, stepped up hiring would be key margin headwinds,” said Suyog Kulkarni, senior research analyst at Reliance Securities.
The management acknowledged that some costs related to office travel and salary hikes could come back. However, the management feels maintaining Ebit margin at around 15% seems feasible. It should be noted that Tech Mahindra saw a drop in headcount in the December quarter, but it is looking at some skill-based hiring going ahead. Analysts caution that hiring based on specific talents could come at a higher cost. Also, the company will be giving salary hikes soon. The management said, its first batch of employees would get their appraisal letters by March of 2021.
Another important takeaway for investors was the total contract value of new deal wins, which stood at $455 million, up 8% q-o-q. The management said the new deal wins do not include renewals, considering that the company has almost reached pre-Covid levels. The management said it is faring well in the 5G technology focused areas, its deal pipeline is robust and the company is optimistic going into the next quarter.
Meanwhile, Bloomberg data shows that the stock is trading at one-year forward price-to-earnings multiple of 17 times, lower than the aforementioned peers. Analysts expect decent Q3FY21 earnings to aid valuations.