Despite Q4 earnings knock, Tech Mahindra could emerge most resistant to Covid-19 lockdown impact

Last week, in a departure from the industry pattern, Tech Mahindra reported a sharp decline in profits for its fourth quarter earnings. Unlike most other players in the sector, the Pune headquartered information technology (IT) services firm took a hit from the ongoing Covid-19 pandemic and subsequent business lockdown across the world.

The company’s consolidated net profits declined 29% for the quarter ended March 2020 to Rs 804 crore against Rs 1,132 crore in the corresponding quarter in the previous financial year. Net profits for the full year also declined 6.14%. The company's revenue decline was sharper at 4.1% on an organic basis despite the current quarter numbers being aided by full quarter consolidation of the BORN acquisition. 

The company’s declining fortunes during the quarter could be attributed to a few factors. The business process outsourcing (BPO) business took a knock, business slowed down at the client-end and the network communications business was hit.

Revenues from the telecom vertical declined 8.4% quarter-on-quarter to $528 mn, while enterprise revenues dipped 3.2% to $766 mn. Unlike its peers, the company generates around 40% of its revenues from the telecom vertical.

Pareekh Jain, founder of Pareekh Consulting, a Bengaluru based IT outsourcing advisory firm, said that this was mostly a supply side problem in telecom networks and BPO.

"They were not able to do WFH effectively in these segments which led to an unexpected decline in revenue and profitability, faster than peers. To some extent they will be able to recover from supply side issues and first quarter results should be at par with the larger industry peers," Jain told TechCircle.

Most market analysts see the fourth quarter earnings as a temporary blip. The company, they pointed out, punched above its weight in winning two big ticket contracts -- the $1 billion AT&T contract and the $900 million contract with Prudential. Large contract wins in terms of total contract value (TCV) increased 2.2 times to $3.7 bn as a result of those mega deals.

According to Mumbai based Kotak Institutional Equities, Tech Mahindra has improved its go-to-market for sales and has tapped new channels for large deals with an improved profile of large deals teams, all of which helped the company in the increased deal pipeline and win rates.

"Willingness to work at a lower profitability profile has also helped. We believe the company can consistently win large deals in telecom and occasionally surprise with mega deals on the enterprise segment. Lockdown/travel restrictions and reprioritisation of investments by clients are some of the hurdles facing new large deal signings," said Kawaljeet Saluja, head of research at Kotak.

The company's short term, as well as the medium term outlook, remains bullish on account of its exposure to the telecom sector. 

With a majority of the global population working from home, the increased demand for broadband and data has seen the telecom sector gain amid the pandemic. Alongside, with 5G implementation gaining momentum in most developed countries, Tech Mahindra's legacy in the sector could help the company to emerge stronger than most of its peers.

CEO CP Gurnani is optimistic about the current financial year despite the setback in the fourth quarter. Demand traction seen in the first three quarters of fiscal 2019-2020 had reversed in Q4, he said at the time of announcing the earnings. "We expect that the focus on digital transformation, remote working, and network modernisation will recover in the medium term," he added.

Jain said that Tech Mahindra should gain from the bump in telecom rooted revenue with the impact being visible as early as during the second or third quarter of the current financial year. "The investments by telcos in  5G and other services is likely to increase and should benefit Tech Mahindra. Revenue from the telecom vertical should see a good growth (above company average) in next two-three years if the company is able to capitalise. Getting margin in large telecom deals could be a little challenge but revenue growth prospects are good," he added.

The company's outlook certainly looks better than peers taking into account the fact that it has less exposure than other players to troubled verticals such as airlines, travel, energy and retail. In fact, retail, travel and logistics together contribute only 7% of the company's revenue. 

Most analysts expect financial year 2019-2021 to be a washout for the Indian IT services industry due to the pandemic induced recession when the world economy is expected to contract and customers are expected to conserve cash by reducing IT spends as well as discretionary technology investments.

The financial sector, the revenue mainstay for theIndian IT services industry is also expected to recover this year owing to large digitalisation initiatives by major global banks. The sector accounts for another 15% of Tech Mahindra's revenue. The manufacturing sector, which contributes 18% of revenues, is also expected to accelerate once the lockdown is eased and supply chain bottlenecks are resolved.

Meanwhile, this week will see two of the remaining large IT services firms -- Noida-based HCL Technologies and Teaneck, New Jersey-based Cognizant -- announce their fourth quarter earnings. 

While HCL had said that it sees only minimal impact on account of Covid-19 in FY 20, Cognizant, which follows the calendar year for its financial accounting, had withdrawn an already low growth projection.

Over the last few months, Tech Mahindra acquired Cerium Systems for $34 million and Zen3 Group for $64 million in all-cash deals. Last month, it announced a collaboration with Armonk headquartered technology giant IBM to help businesses transform their operations and accelerate hybrid cloud strategies while establishing innovation centres to address business problems across multiple industries.