Tech Mahindra faces many hurdles on road to recovery

Prospects of a faster recovery may have driven up frontline information technology (IT) stocks, but expectations at Tech Mahindra Ltd remain muted. While the Nifty IT index is up 13% from its February highs, Tech Mahindra is still down 10%. However, there are signs of improvement. Conversations on projects that had come to a standstill are picking up, and many small deals are resuming, said Motilal Oswal Financial Services.

Supply side constraints that hit its revenues in the June quarter are mostly resolved. If revenues improve, margins will rise. “Lower travel costs, rationalization of facilities, and improvement of margin profile of two large deals would support the company’s margin improvement in Q2FY2021,” Sharekhan Ltd said in a note.

But, unlike larger peers, a big portion of Tech Mahindra’s revenues are generated by two industries—communications and manufacturing—which are seeing sluggish spends.

Capital expenditure on 5G, which is expected to provide a fillip to its communication business, is delayed.

“Due to uncertainties in the wake of pandemic and deferment of spectrum auction across markets, communication service providers have pushed the 5G roll-out related spends, and it is expected to rebound in 2021,” added Sharekhan.

Weak end-consumer demand in auto and aerospace is weighing on recovery in the manufacturing vertical.

Consequently, the near-term performance is expected to be driven by healthcare, financial services and technology, which together generate less than half of its revenue.

Cloud and digital services are seeing good traction and the deal pipeline is healthy. Moreover, Tech Mahindra sees good opportunity in network services and believes it is well placed to capture the 5G technology spends.

However, the proof of the pudding will be in the eating, and the stock’s valuation discount to larger peers reflects investor concerns.

“While Tech Mahindra has identified exciting opportunities around 5G and has developed market-ready offerings, pickup of these is dependent on large-scale investment in 5G infrastructure by communication service providers and 5G adoption by enterprises,” Kotak Institutional Equities said in a note.