The IT sector has been on a downward trend in the last 1 year after a massive surge post the COVID pandemic. Between January 1, 2020, and March 31, 2022, the Nifty IT index rose by approximately 144 percent. However, since March 2022, the index has shed 21 percent.
The sharp run-up in inflation globally, and the resultant aggressive monetary policy actions by central banks in the developed economies (the major market for IT companies) to contain inflation resulting in recessionary expectations gradually gaining ground impacted the entire sector. The expectations of a slowing economy transforming into lower digital spending were also reflected in the price performance of domestic IT companies.
Amid this backdrop, let's compare IT stocks LTI Mindtree (LTIM) and Tech Mahindra to figure out which offers better long-term investment opportunities.
Stock Price Trend
Shares of both Tech Mahindra and LTIM have not performed well in the last 1 year, down over 22 percent and 24 percent, respectively. In comparison, the Nifty IT index has declined 20 percent in the last 1 year.
However, on a YTD basis, both the stocks have been in the green with Tech Mahindra up over 10 percent and LTIM up over 8 percent in this period. Meanwhile, in the last 1 month, LTIM has fallen nearly 3 percent whereas Tech Mahindra has been muted, down less than half a percent.
In the long term, LTIM seems to be the winner. It has surged over 3 times, up 243 percent in the last 3 years while Tech Mahindra has risen 94 percent.
About the firms
Tech Mahindra is an Indian multinational information technology services and consulting company. Part of the Mahindra Group, the company is headquartered in Pune and has its registered office in Mumbai. Tech Mahindra is a $6 billion company with over 158,000 employees across 90 countries. The company operates through two segments: Information Technology (IT) Services and Business Processing Outsourcing (BPO). Its geographical segments include the Americas, Europe region, India and the rest of the world. The company’s products/services include telecom services, consulting, application outsourcing, infrastructure outsourcing, engineering services, business services group, platform solutions and mobile value-added services.
LTIMindtree Limited is an Indian multinational information technology services and consulting company based in Mumbai. A subsidiary of Larsen & Toubro, the company was incorporated in 1996 and employs more than 90,000 people. In May 2022, it was announced that Mindtree, which was the other IT services subsidiary of Larsen & Toubro, will be merged into LTI, and the company will be renamed as LTIMindtree. The merger was completed in November 2022. After the merger, LTIMindtree became India's fifth-largest provider of IT services by market capitalisation and sixth-largest by revenue. Shares of Mindtree were delisted and shareholders were allotted 73 shares of LTI for every 100 shares of Mindtree held. The parent company, Larsen & Toubro, held a 68.73 percent stake in the merged entity.
The company is engaged in the business of analyzing, designing, maintaining, converting, porting, debugging, coding, outsourcing and programming software and also providing information technology-enabled services. Its services include cloud and infrastructure training, consulting, customer success, cyber security, data and insights, digital engineering, Disruptive software-as-a-service (D-SaaS), platform operations, intelligent automation solutions, and assurance and quality engineering.
Tech Mahindra's consolidated net profit for the quarter ended December declined 5.3 percent year-on-year (YoY) to ₹1,297 crore. Its revenue from operations increased 20 percent YoY to ₹13,735 crore. Sequentially, the net profit rose about 1 percent and the revenue by nearly 5 percent. Dollar revenue rose 1.8 percent sequentially at $1.67 billion. In constant currency terms, sales grew 0.2 percent sequentially and were largely on expected lines. Operating profit, calculated as earnings before interest, taxes, depreciation and amortization (EBITDA), rose 8 percent sequentially and 4 percent YoY to ₹2,144 crore, the company said. The net new deal wins for the quarter was $795 million, higher than $716 million a quarter ago, and $704 million a year ago. Operating margin, calculated as EBIT improved by 60 bps sequentially to 12 percent.
“We are witnessing moderation in growth given the tough macroeconomic environment. We will continue to work with our customers to pre-empt their technological requirements and identify new demand drivers, especially for digital services,” C P Gurnani, managing director and CEO of Tech Mahindra was quoted as saying in the release.
LTIM posted a 4.7 percent fall in net profit to ₹1,001 crore for the fiscal third quarter, missing estimates due to a seasonally weak quarter and integration costs related to the merger. This was the first time the L&T Group-backed firm is reporting its quarterly results post the L&T Infotech and Mindtree merger in November. Its net profit stood at ₹1,050 crore in the year-ago period. The consolidated revenue of IT grew by 25.3 percent to ₹8,620 crore in the quarter under review against ₹6,880.7 crore in the corresponding quarter last fiscal. Sequentially, the profit fell 16 percent and revenue rose 5 percent.
"As expected, our Q3 profitability has seen a one-off impact of merger-related integration cost to the tune of 100 basis points. With the bulk of the integration cost behind us and in view of the growth tailwinds ahead, our endeavor is to return to our normalised profitability in Q4," said Debashis Chatterjee, Chief Executive Officer and Managing Director of the combined entity.
Which is a better stock for long term?
Omkar Tanksale, Senior Research Analyst, at Axis Securities, believes LTIMindtree is a better bet as it has better upside potential, strong valuation comfort and a better service mix. It has a robust broad-based deal pipeline and strong execution capabilities, said Tanksale, adding that moderated supply-side constraints easing the sub-con cost may help the firm to gain margins in forthcoming quarters.
Meanwhile, Deepak Jasani, Head of Retail Research, at HDFC Securities, also picked LTIMindtree. “Based on our one-year targets, LTI Mindtree has a little more upside than Tech Mahindra,” he said.
"As a combined entity, LTI Mindtree expects to report US$ 1 bn in revenue synergies over four to five years. An increase in deal pipeline and a greater proportion of large deals supported by strong client mining credentials, strong cross-sell and up-sell opportunities supported by vertical and service-line synergies with limited client overlap, and operational synergies supported by access to a wider talent pool could translate into strong growth going forward," rationaled the market expert.
For Tech Mahindra, Jasani pointed out that it has trailed its peers in growth and operating performance over the recent past, however, with reducing operational headwinds like the cost of delivery, sub-contract cost, and attrition, the delta on earnings for Tech Mahindra could be higher than its peers in FY24E (high teens growth vs. mid-teens for peers). In any case, drivers such as organic growth focus, synergy extraction from earlier acquisitions and delivery optimisation (sub-contracting & offshoring) can lead to a ‘catch-up’ on the operating profile, he added.
However, Vinit Bolinjkar- Head of Research - Ventura Securities, prefers Tech Mahindra over LTIM.
"Tech Mahindra is trading at FY25 P/E of 14.4X, while LIMindtree is trading at FY25 P/E of 21.8X. Tech Mahindra is comparatively cheaper than LTIMindtree and therefore it looks better. Furthermore, the rollout of 5G may enhance the business prospects for Tech Mahindra, which provides better revenue visibility compared to LTIMindtree," Bolinjkar explained.
Finally, Mohit Jain, Research Analyst, Anand Rathi Institutional Equities said that he likes both the names currently from a one-year perspective.
Tech Mahindra is seeing leadership additions that can help them build in BFSI, healthcare, and large deals; potentially with better profitability and higher FCFs (free cash flow). Meanwhile, LTIMindtree is also at an interesting junction and is one of our top picks in the space, he noted. In the first leg (say over the next 2 quarters), there are expectations of margin recovery and then in the second leg (say another 2 quarters later), there could be some acceleration as synergies start playing out and merger-related issues dwindle away, added Jain.
Outlook and strategy
On the back of recent corrections, experts believe the IT sector provides a good ‘buy’ opportunity.
Vinod Nair, Head of Research at Geojit Financial Services, advised that the ongoing sell-off can be used as an opportunity by long-term investors because the outlook is intact as the decent amount of correction is attractive. In terms of valuation, the sector has corrected heavily from extreme peak levels to just above its long-term range, he said.
Jain from Anand Rathi also said, "We think it's time to start accumulating IT stocks. While more correction is always difficult to predict, one can offset some of these risks by building the desired position over say 6 months rather than at once. This will help absorb the volatility in current prices. Also, from a timing standpoint, Nifty IT is down 20 percent in the last 12 months and 27 percent from the peak. This, in my opinion, is a good starting point."