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Tuesday, December 9, 2008

Buy Tech Mahindra - Emkay Financial Services

Emkay Global Financial Services Ltd has maintained 'buy' recommendation with a revision in the target price.

The target price at Rs 320, based on 6 times adjusted FY10 earnings of Rs 53.4 has been given. Emkay has revised the estimation for currency assumptions (the brokerage base H2FY09 estimates at GBP/$ of 1.5 and 1.4 for FY10/FY11, $/INR at Rs 47/$ and Rs 46/$ for H2FY09/FY10 and FY11 respectively). The company ended at Rs 252.15 on Friday.

The brokerage noted that Tech Mahindra's estimated volume growth could all be nullified on account of currency alone during FY10. The brokerage expects the company to report earnings at Rs 60.9 and Rs 66.7 in FY10 and FY11 respectively. Despite expecting 14 per cent decline in earnings during FY10, Emkay believes that inexpensive valuations limit any significant downside from current levels.

Tech Mahindra has underperformed sector peers significantly in past 3 months driven by the sharp depreciation in GBP/EURO v/s Rs. The brokerage note that Tech Mahindra derives 70 per cent of revenues in GBP and further with the company's higher offshore proportion of revenues (Tech M offshore-onsite split of revenues at 60:40, much higher than other sector peers), Tech Mahindra's operating margins as well as earnings could be severely dented on account of GBP depreciation.

Thus we believe that the company's Q2FY09 operating margins at 28 per cent, the highest ever in the company's history could remain so for atleast multiple quarters going forward. Per new currency assumptions, Emakay believes there is a strong likelihood of Tech Mahindra showing a decline in earnings in FY10 as the brokerage expects Tech Mahindra to report earnings of Rs 61 in FY11, 14 per cent YoY decline.

Tech Mahindra's currency woes could stand compounded with some demand side concerns both at it's anchor client BT as well as the other non BT clients from the TSP space. Emkay highlights that the growth in revenues from the telecom vertical for offshore IT vendors has been led by the strong capex tailwind which could be dry up going forward. In brokerag's view, although the company remains vulnerable to cuts in IT spends at TSP's (given sole focus to the telecom vertical), budget constraints at British Telecom could drive 'market share gains for Tech Mahindra.

Further the company's strategy of signing large deals provide revenue assurance over an elongated period (the brokerage highlight that apart from mega deals of $1 billion plus and $700 million at BT, co had also secured a $350 million deal with BT which converted $50 million per annum of revenues through multiple contracts into annuity business for atleast 5 years).

The management has reveal that the ramp up on (1) the BTGS deal (although initial transition had been delayed by atleast second quarters to start with) is running as per schedule and (2) $700 million deal (on which the company has shared very little details with investors) is as per initial expectations and thus co remains confident on booking revenues from the contract from Q1FY10 as envisaged initially.

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