Brokerage firm ICICI Securities has upgraded the rating on Tech Mahindra to 'buy' from an earlier rating of 'sell' with a target price of 1,552 apiece. The brokerage believes that the company's new CEO, Mohit Joshi, can easily improve the company's EBIT margin. It said that the new CEO has already made positive moves by appointing Atul Soneja as COO and taking the right steps in the company’s turnaround efforts.
The brokerage has compared key operating metrics of Tech Mahindra with the top four large-cap Indian IT peers, analysed the profitability of acquired subsidiaries, and analysed the improvement in margins of Zensar and Birlasoft post-appointment of new CEOs. Based on this analysis, the brokerage believes that there are several low-hanging fruits that the new CEO Mr Mohit Joshi can act upon to improve margins quickly.
At the same time, the brokerage analysis of the company's vertical and service line capabilities based on Gartner and ISG ratings as well as competencies of IT companies as listed on SaaS and Hyperscalar partner websites and TechM’s vertical-wise revenue growth, deal wins, and client mining performance vs. peers suggests that the new CEO needs to invest around building capabilities in noncommunication verticals, invest in sales teams, and change the incentive structure of sales and delivery operations for improving account mining and large deal wins for improving the top-line performance of the company.
The brokerage has also analysed the successful turnaround in Mahindra & Mahindra’s auto business and financial services under the leadership of Mr Anish Shah, MD & Group CEO, Mahindra Group. Thus, it believes that the parent Mahindra Group plans to bring about a similar turnaround in Tech Mahindra, led by new CEO Mr Mohit Joshi.
Quick margin improvement is possible by targeting low-hanging fruits
The company targets to improve EBIT margins to 15–16% by FY25–26. The brokerage points out that the company has the highest sub-con costs as a percentage of revenue among large-cap IT peers, and the management targets to reduce this from the current 14% to 11% over the next two years. Also, it said the company has the highest onsite revenue mix at 60% compared to its large-cap IT peers, and the company is targeting to reduce this by 4–5%.
Further, the company has a separate delivery organisation for each geography and for BPO and certain other service lines. Management plans to centralise the delivery organisation to improve operating efficiencies.
The company undertook divestment of non-strategic businesses (including businesses with low or volatile earnings profiles) in FY23. It plans to continue this process in FY24 as well. The margin benefit of this divestment may not be significant, but it will free up management bandwidth, it added.
Potential for a structural re-rating
"Tech Mahindra valuation at 19x/17x looks stretched on consensus FY25/26 EPS estimates. But if the company achieves its objectives under the new management, then the stock carries the potential for a structural re-rating," said ICICI Securities.
39 analysts polled by MintGenie on average have a 'hold' call on the stock.
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