Low valuations don't make TechM a cool bet; investors advised caution

Though IT network spends are expected to see traction after Covid-19-led disruptions are behind, 5G roll-out, which is keeping sentiment elevated for TechM’s stock, could take a backseat in the near term.
Despite a disappointing March quarter (Q4FY20) performance, Tech Mahindra (TechM) shares are up 5.5 per cent in a week. This may be an attractive valuation of 12 times FY21’s estimated earnings, based on hopes of execution of large deals secured earlier, and the stock’s underperformance in the past year. However, there are downside risks in the telecom segment, which contributes over 40 per cent of TechM’s business.

Many analysts, thus, foresee a 4-9 per cent decline in TechM’s top line (in $ terms) in FY21 (versus a 4.3 per cent rise in FY20). HDFC Securities, which has a ‘buy’ on the stock, expects TechM’s FY21 revenue to fall 4.7 per cent, with an 8.7 per cent fall in telecom business, which grew 5.3 per cent in FY20. 
Though IT network spends are expected to see traction after Covid-19-led disruptions are behind, 5G roll out, which is keeping sentiment elevated for TechM’s stock, could take a pause. Clients are focusing on maintaining their existing network in the current situation, rather than 5G. TechM’s management, during the Q4 earnings call, indicated that logistical challenges with execution amid the lockdown should lead to near-term delays in network upgradation/5G deployment. PhillipCapital, which has a ‘sell’ rating on TechM, says the entire investment thesis is resting on the 5G pillar, which keeps getting pushed into the future.

 

 
Further, network services and business process management segments are facing higher supply issues related to data security and work from home. While TechM expects these issues to ease out in Q1FY21, some analysts are sceptical. Amit Chandra of HDFC Securities says: “While the 5G project would get delayed, more top line pressure for the telecom segment in FY21 would stem from network services and BPM.” 

Analysts are also unclear on how the execution of large deal wins would pan out in FY21. Pricing pressure from clients due to liquidity crunch is adding to concerns. Expectations of margin recovery have now been shifted to FY22, from FY21 earlier. Analysts foresee 40-120 basis point contraction in earnings before interest and tax margin in FY21, to 10-11 per cent, because of limited scope to improve utilisation and rising subcontracting. Motilal Oswal Securities has cut TechM’s FY21 and FY22 EPS estimates by 22-24 per cent, and downgraded the stock to neutral.

Overall, investors should await traction in 5G roll out and easing of supply disruptions, before falling for cheap valuations.


Business Standard is now on Telegram.
For insightful reports and views on business, markets, politics and other issues, subscribe to our official Telegram channel