Tech Mahindra Ltd. ADR (TCHQY) Q4 2023 Earnings Call Transcript

Tech Mahindra Ltd. ADR (OTC:TCHQY) Q4 2023 Earnings Conference Call April 27, 2023 8:30 AM ET

Company Participants

CP Gurnani – Managing Director, Chief Executive Officer

Rohit Anand – Chief Financial Officer

Jagdish Mitra – Chief Strategy Officer and Head of Growth

Manish Vyas – President, Communications, Media and Entertainment Business, and CEO, Network Services

Vivek Agarwal – President, APJI (Enterprise), BFSI & Corporate Development

Birendra Sen – Business Head, Tech Mahindra Business Process Services

Harshvendra Soin – Global Chief People Officer and Head, Marketing

Conference Call Participants

Abhishek Bhandari – Nomura

Sandeep Shah – Equirus Securities

Sudheer Guntupalli – Kotak Mahindra Asset Management

Girish Pai – Nirmal Bang Institutional Equities

Manik Taneja – Axis Capital

Operator

Ladies and gentlemen, good day and welcome to the Tech Mahindra Limited, Q4 FY ‘23 Earnings Conference Call. As a reminder, all participant lines will be in the listen-only mode, and there will be an opportunity for you to ask questions after the presentation concludes. [Operator Instructions]. Please note that this conference is being recorded.

I now hand the conference over to Mr. CP Gurnani, MD and CEO for Tech Mahindra. Thank you, and over to you sir.

CP Gurnani

Thank you. Good evening everyone. I am really happy that FY’23 has proved to be yet another year of double digit growth, and particularly proud that our large deal wins have been about $3 billion. I am also very happy that CME, despite of all the challenges, has continued to grow for 12 quarters in a row.

On the enterprise side we have touched $1 billion quarterly run rate, which means really $1 billion businesses have been built in BFSI and manufacturing, and also very happy that the technology investments or skilling investments our company has made on Quantum Computing, Metaverse on Blockchain, Web 3.0 Cloud, and the customer experience management are yielding good results.

We continue to be driven to make our customers successful, and we do believe that while the global economic outlook continues to be little uncertain, the macro indicators and the actions of the monetary authorities, the impact because of some of the regulatory or the policy decisions taken is resulting in some of our customers slowing down for the time being.

But I know if our customers are cautious, we need to be cautious, but the other way of looking at it is that Tech Mahindra is a company has always believed that never waste a crisis. And we would like to develop our investment in people up-skilling, we want to develop our investment in technology, we want to develop our investment in prioritizing a few markets like Japan or Middle East, because we generally believe that there will be more lapped deals because our clients will eventually want to move to new platforms, would want to move away from legacy to digital, and I think this economic downturn will force decision making, particularly from legacy to digital.

So as my clients adopt new technologies, they look at how they will meet some of their customer demands, I think Tech Mahindra will be ready alongside with our clients to become agile and relevant for the next few quarters. My personal belief is that, that this phase is temporary and we will see a recovery within FY’24 and hence I remain more determined to be aligned with our customers, be aligned with our partners, and deliver value and deliver more technology benefits.

Just a quick recap on the numbers, FY’23 constant currency 13.7% growth, margins yes, they’ve been under pressure. But as I said, if we look at investments, if we look at the potential for us to look at certain operating efficiencies, particularly on automation, I think there are enough operating levers for us. We do believe that because Tech Mahindra has invested a lot in Quantum and in AI, we are looking at predictive technologies, data sciences, cloud in a much bigger way. So my belief is, as we adopted to our existing projects, we should be able to bring out some of the efficiencies.

In general the Q4 earnings, I know Rohit will cover in detail and so annual basis, closing the year with $6.6 billion of revenue for this quarter, largely it’s at $5.92 million, but as I said last year we did $3 billion and we will do a lot better this year, because our clients want to take some big decisions. They may have a little bit of a hesitancy right now, but eventually looking at improving their own utilization also.

On the dividend side, our capital allocation policy is consistent. Capital allocation is, if we have extra cash we will return it. So our board has agreed to recommendation of final dividend and the total dividend now becomes INR50 rupees for the year. So I again want to repeat that to me, the software environment is an opportunity and Tech Mahindra is geared for that opportunity through our own investments and technology and automation.

So again, thank you for your support. Thank you for being with us during this tough time or softer times, but I do promise you that the company is a lot better engaged and lot better engineer for both growth and profitability.

I’m joined with my colleagues Manish Vyas, Jagdish Mitra, Vivek Agarwal, Bir Sen, CTL. So we will have a free flowing debate, but before we start with the question-and-answer, I’m going to request Rohit to take you through the numbers a little more in detail. Thank you again. Thank you everybody.

Rohit Anand

Thank you, CP. So, good evening to everyone. Let me now cover the complete financials for the fourth quarter and the year ended 31 March 2023.

We ended Q4 with a revenue of $1,668 million, marginally up compared to Q3 constant currency. CME verticals grew 1.8% QoQ on a CC basis, while enterprise vertical decreased by 0.7%.

Our deal wins were at $592 million for the quarter and generally in rupee terms was INR13,718 crores versus INR13,735 crores in Q3, down 0.1% QoQ. The EBIT for the quarter was at $186 million versus $200 million in Q3. The EBIT margin of 11.2% versus 12% last quarter. The reduction of 80 basis points was largely contributed by currency, impact of 60 basis points and SG&A impact of 90 basis point. These were offset by productivity actions that we had articulated in the past that we had been working on, namely around sub-con reductions, which came as a tailwind of 70 basis point.

Moving below EBIT, other income of the quarter was at $37 million. We had a ForEx loss of $1 million compared to a gain of $15 million in Q3. There was one off in payment costs of $26 million in Q4 which was reported in the financial this quarter. We continue to follow from an FX perspective on all basic hedging policy which has helped us deliver good results over a longer period and we will continue to follow that as we move forward as well.

From a tax rate perspective, we were at 26.2% for Q4 versus 27.4% for Q3. As we had said before, our normalized ETR for the year is in the range of 25% to 26%, so that continues to be the bad. From a net profit margin for the quarter it was 8.2%, a decrease of 120 basis point versus Q3. Free cash flow was $142 million which was 104% of that. Our DSO have reduced by two days to 96 in Q4 versus 98 in Q3.

Moving on to the fully year performance, revenue stood at $66.07 million with a constant currency growth of 13.7%. In rupee terms our revenue was INR533 billion at a yearly growth of 19.4%. During the year communication business grew as I mentioned 30.4% and enterprise grew 30.9% in CC terms.

Within enterprise technology, retail and manufacturing was a major growth driver for the year.

We ended the year with an EBITDA of $990 million and EBITDA margins of 15.1%. The EBIT for the full year was $747 million, and EBIT margins stood at 11.4% versus 14.5% in FY22.

This decline of broadly 300 basis point was driven by headwind due to the various stations that we saw on the supply side, more attributed towards the first few quarter versus the last quarter. SG&A travel costs with some of the normalization post-COVID increasing year-on-year.

Some of the deal M&A related costs that we had articulated before, around 50 basis point, and then the large deal cost where the ramp up in the recent favor of Lal [ph] deal reduces and the recovery of efficiency happens in later years, so that was around 70 basis points.

The offset for the year was driven by pricing. We had communicated at the beginning of the year that we will target close to 1% of expansion due to price, and that is what we’ve delivered close to that number. From a sub-con perspective we’ve had a reduction, so hence that has contributed 80 basis point and then we continue to drive more offshoring that has helped us give a benefit of 30 basis point.

Going below the EBIT line, other income for the year was $119 million. Other income year-on-year was lower because of lower ForEx gain compared to last year. When we look at our hedge book, it was $23.35 million with a mark-to-market gain on outstanding covers as of 31 March 2023 being $30 million. Based on the head accounting treatment, a gain of $4 million will be taken to the P&L and the $8.9 million residual has gone to reserves.

Free cash flow for the year $497 million, which was 84% of bad conversion. DSO year-on-year went down by one day. Cash and cash equivalent at the year end stood at $905 million and in INR terms 7,435 crores.

In line with our commitment to total capital allocation that C.P. articulated, we continue to return cash to shareholders. The board as per our recommendation has approved a final dividend of INR32 rupees per share, taking the total dividends for FY’23 to INR50 per share, which is an expansion from last year by close to 11% from INR45 a share. This translates to a dividend payout ratio of 91% for FY’23. And now in summary I would like to reiterate the execution strategies focused on portfolio synergy operating rigor and people task permission as we move into the next fiscal.

With this commentary I will open the floor to questions and with all the leadership team, we’ll take each question one-on-one.

Question-and-Answer Session

Operator

Thank you very much. [Operator Instructions]. The first question is from the line of Abhishek Bhandari from Nomura. Please go ahead.

Abhishek Bhandari

Yeah, thank you for the opportunity. Rohit I had a question on the margin performance for Q4 and the path going forward. Now if you could help us explain what happened on the SG&A part that there was such a sharp increase. And if I look at the commentary since the start of the year and also in the analyst meet, the visibility on you recovering back to the FY’22 margin towards FY’23 seems to be very hazy. If you could help us understand how should we think about margin expansion from here, and Q4 in particular the SG&A what happened.

Rohit Anand

Yes, so from a G&A perspective maybe to start at Q4 first. So we continue – I mean, from an investment perspective, we continue to invest more in terms – from a business process perspective and system perspective. We are taking a longer term view here, so that continues.

We did have some year-end costs which was trued-up and then will get normalized as we move into the next year. I think our view is that SG&A as a percentage of revenue should be in the band of around 13.5% for us, so that should get normalized.

When you look at future viewing on the margin, right, as we move from here, as I’d mentioned in the estimate also in March, I think the levers are same for us and we have delivered in the current quarter as well. If you look at the direct cost aspect, we said that sub-con will be something that will keep on working on and that you’ll see a dramatic reduction there. We will continue to work on four, five levers that we said earlier. I think our large view, we’ll get a little bit more maturity in terms of where they are to, where we want them to be next year, so that’s one leaver.

Second, we had articulated we still have almost 4% to 5% improvement opportunity in our offshore rates versus where we today, that we’ll continue to drive. We also said that we’ll continue to drive pyramid nationalization, and that’s an investment we are going to bake into FY’24, so that’s a lever we’ll continue. We also said that we will take some structural action to divest or stop and seize our non-profitable or low profitable businesses. So we did some action last year and we’ll continue to execute on the pipeline we have to expand margins on that front as well. And then within sub-con as well, while we continue to reduce it, we’ll also drive better margin mix there by improving the mix.

So those are few actions that we will continue to drive as you move forward, and I think directly our commentary is the same that we have more opportunities to continue to expand it. Obviously the macro environment in the last two quarters, and as we look at the next two quarters, relatively different than what we seen in the last beginning of the year, and that our view is as we move into the second half it will get better again to where we were. So in terms of view on macro first half, we’ll be more cautious versus the second half.

Abhishek Bhandari

So if I can understand it correctly, the margin improvement for FY’24 is contingent on a better second half of FY’24.

Rohit Anand

I would say margin improvement will be irrespective target or view that we will go for. But when we look at our demand scenario and our overall macro environment, vis-à-vis the vertical and all the mix that we have, from a view perspective second half, in our view it gets better than maybe uncertain. So that’s not the basis on which we’ll drive our margin action.

Abhishek Bhandari

Okay, thanks Rohit for that. The second and final question is on your top five client outlook.

While you’re already kind of signaled it into last quarter that the top five clients might remain soft for some more time. If you could help us understand how should we think about this bucket going into FY’24? How long do you think the decline in this particular thing would continue?

Rohit Anand

Yeah. So I think as I mentioned, it is bottoming out. As we speak there are certain plus and minus there. But generally the trend seems to be stabilizing and as we move forward while I can’t share any customer specific information, but we’ve had the majority of the impact and should be towards the target of that.

Abhishek Bhandari

Okay, thank you Rohit and all the best for FY’24.

Rohit Anand

Yeah.

Operator

Thank you. Ladies and gentlemen, we request to please limit your question to one per participants. Should you have any further questions you may join the queue back.

The next question is from the line of Sandeep Shah from Equirus Securities. Please go ahead.

Sandeep Shah

Yes, thanks for the opportunity. This is the second quarter in a row where constant currency growth is almost like flattish, and Rohit you also mentioned that the first half would be cautious. So how do you see FY’24 in terms of the growth rates? Will it be second half heavy? Will it continue to remain tapered in the first half, despite we believe the top five clients specific issues are largely again behind. So how do you expect whether then would be a growth pump up from the last few quarters in the first half itself or you still believe first half would be cautious and growth revival would only be in the second half?

Rohit Anand

Yes, thanks Sandeep for the question. As I had mentioned, while I won’t give a number of guidance but directionally that is true. I think the headwinds that we’ve seen from a growth perspective when you compare our second half this year versus the first half, from a headwind perspective, macro side, that trend in our view and looking at our mixed customer verticals all that, our view is that trend continues in some form of shape for the first half.

The pipeline is still robust, right, across the segment. There are good deals discussions happening. There’s a mix change in terms of deals dynamics also, but from a pipeline discussion perspective it’s quite favorable overall, right. But the trend wise, yes, first half versus second half is kind of a reflection of a reverse mirror reflection of what we saw last year as of the current view.

And as we move forward, we keep on updating you on what changes are we seeing across industries vertical and geography. But I can also request, Manish is there, we’ve got Jagdish and Vivek, they can add some favor on their side of the business to give you perspective as well.

Manish Vyas

Well, thank you Rohit. No, I think I’ll just add that the broad sentiments continues to remain, that the investments from a tech standpoint I think remains a top priority for most of the customers that we talk to, either it is to find operational efficiencies or to continue to modernize. What clearly happens in uncertain times like these and some of that story is playing out in the second half of the last fiscal is some of the discretionary spend and the transformation projects do, they do go through another added lens of evaluation before the money is released. So that’s what we are seeing at this point in time and that of course sometimes has an effect on the OpEx as well.

We do believe that as things become most certain, the second half of the fiscal I think we’ll start seeing the positive swing and some of the large deals that we are pursuing now are as – some of them have got delayed from a decision standpoint. They never let remain extremely important for each of these customers to decide at some point. It could be a month, it could be sometimes more than four months. As those decisions manifest, I think it will start translating into revenues towards the second half of the year. I hope that helps you.

Sandeep Shah

Yes, and commentary on the enterprise.

Jagdish Mitra

Hi, so Jagdish here Sandeep. Thank you. I think pretty similar in terms of behavior. The digital transformation journey as we all recognize is a train that’s definitely not stopping and it’s a lot of demand in the customer base of what to do in terms of bringing transformation in different levels. So even cost take-out is ultimately leveraging these technologies which C.P talks about where we’ve invested in and we are starting to see a lot of engagement on that, whether it is AI, whether its data analytics, whether it’s some of the work that we’re doing in Quantum, etc.

Pretty similar to what Manish said, decision making is going to be prolonged. People will look at it a multiple few times. But the conversations are there and obviously more of the discussion is towards cost take out related deal structuring and transforming the core functions, whether its supply chain, whether it’s back office operations and so on and so forth and it’s pretty uniform across enterprise, industry vertical. Some little more than the other, but more or less the good part of it is the tech conversations and the transformation conversations continue. So confidence and bullish that the transformation journey is definitely not slowing down.

Sandeep Shah

Okay, and just to follow up in this outlook for growth, which may be tapered in the first half, how do we see wage hikes and timing of the wage hikes? Will it fall into place by 1Q, 2Q, which we generally do as a whole or there could be some delay in there?

Harshvendra Soin

So, this is Harish and thank you for asking that question. So like we have done in the past, we continue with the same strategy of staggering the hikes suitably as we view a quarter-on-quarter. So we’ll follow the same strategy this year too.

Sandeep Shah

So it will be across four quarters of FY’22.

Harshvendra Soin

We will stagger it. We don’t know if it will be two quarters or four quarters, but we’ll stagger it for sure.

Sandeep Shah

Okay, thank you.

Operator

Thank you. The next question from the line of Sudheer Guntupalli from Kotak Mahindra Asset Management. Please go ahead.

Sudheer Guntupalli

Yeah, thanks for the opportunity. One of our competitors saw a sharp decline in communications, and thereafter the expectation was that we should see a sharper impact give our concentrated exposure to this vertical line, and some of our top clients are from this vertical. However, your performance in communications is fairly…

CP Gurnani

Sorry, what’s the question.

Sudheer Guntupalli

So what is driving the optimism that top account issues are still bottoming out, close to bottoming out? Is this being led by the fact that you had already gone through a relatively longer period of softness in this vertical, and accordingly you think a lot of it is already in the base?

Manish Vyas

I think on the contrary, I think you heard in the opening comments and I think I’ve also been saying it for some time. We have actually seen a consistent growth in the telecom vertical now for the last three years. I think this is actually a quarter of celebrating a few interesting, important milestones in our lives.

One, we did say and give all of you an early indication on 3 March, that we should be getting to close to $1 billion run rate as far as our 5G business is concerned, and as you know we invested mostly organically in capabilities, solutions across the broad range of the 5G spectrum, from software to services to integration to test to managed services, automation included. All of that has translated indeed into that $1 billion number that we, from a run rate stand point that we have did.

Other very interesting and important, I’m sure all of you would recall, that back in the day of 2015, I mean I’m taking you eight years back, we did invest in LTC and that didn’t play out that well at the time, but we have been consistent in saying that our commitment as a technology agnostic independent integrated and managed service provider to the network, both Carrier and Enterprise Network, I think is a huge differentiator for your companies. That also played out extremely well. I think while we don’t break those business unit numbers often, but at this point I’m happy to report that it’s seen one of the fastest growth. It should be close to $1 billion by the end of this year as far as even our network business is concerned.

So where our, I don’t know whether you call it optimism or our strong belief in this industry vertical is. I think it’s largely because of the support that all of you have provided in continuing to invest and becoming a market leader in this space with a wide margin. As far as telecom is concerned, there is not a single telegram service provider in every market that we want to operate in that we do not serve today.

So now granted that’s one quarter or two or a little uncertain at a macro level does not define our presence, our strength, our investments, and our performance in this sector, I think from a long-term standpoint, I wish I had a crystal ball to say whether it’ll be third quarter or fourth, but I definitely can say this, that from a mid-term to long-term standpoint, he discussion that we are having with this sector are absolutely all-time best, and I don’t think we need to be concerned about it.

Sudheer Guntupalli

Okay, thanks Manish. That’s a very encouraging message tonight.

Operator

Thank you. The next question is from the line of Girish Pai from Nirmal Bang Institutional Equities. Please go ahead.

Girish Pai

Yes, thanks for the opportunity. You mentioned that there’s probably a pickup in growth in 2H. What is that optimism based on? Is it based on some client conversations you’ve had or is it like merely hope?

Rohit Anand

Maybe overall I’ll say that the pipeline is quite robust from where we were last year. So I think that is the first ray of hope if you will. The second is client conversations, which Manish just mentioned, which is what is saying that is quite positive. There is a slowdown in terms of decision making, which is what it was saying, that there are more approval cycles and is the final side of it is taking time, which is what we are kind of cautioning out from a first half perspective. We will continue what we’ve seen in the second half of this year.

From an industrial perspective, if you look at cloud penetration it’s still low. In communication, the 5G penetration is still a lot to desire for, and AI work has started, right? So I think data analytics, on top of cloud, all that from a technology penetration standpoint when you look at all the metrics, it’s positive. So one, two, three quarters, really doesn’t define the long-term trajectory that the business has to offer, and that’s what gives us the optimism, including the discussion we’ve had, and maybe some of them are agent [inaudible] and Manish, Vivek, Jagdish have had many and can elaborate some examples on that.

Manish Vyas

I think the only think I would add to this and we have mentioned this earlier, this is not the first time the story is playing out in this tech industry theory. Well we’ve seen these pressure points and the decisions that typically get made are around modernization, around transformation, around cost-takeout and those conversations have begun now. Like we said, we can’t really predict whether these decisions will happen in six months or eight, but they will happen at some point in time and that’s when we will. So, I think it’s also not a function of hope, but definitely a function of the busyness that we have at this point in our conversation, if that answers your question.

Girish Pai

Yeah, thanks. Just one last one, what’s your view on pricing in the FY’24? I believe you did get some price increases in FY’23. How are you looking at that in ‘24?

Rohit Anand

We’ll have some carry forward effect from last year of the year that will flow through, of the impact of Q2, Q3, Q4, but incrementally while we’ll continue to drive those conversations there, our opportunity on where we should be versus where we are is there. But on a broad-based perspective versus last year it’s going to be quite limited, right, as an opportunity.

I would say, we would continue to work on proactively providing solutions to our customers and we are right now focusing our self to be very close to defining how to look at the future. And hence, positioning ourselves on driving efficiency outcomes of them, which gives us opportunity to get more business, as well as expansion with the same customers. Hence, the cost of acquisition and other efforts goes down to improving the productivity from a business standpoint.

So that’ kind of what we’ll drive, if pricing as a leave is going to be limited this year versus last.

Girish Pai

Okay, thank you.

Operator

Thank you. The next question is from line of Manik Taneja from Axis Capital. Please go ahead.

Manik Taneja

Hi! Thank you for the opportunity. Rohit, I had a question with regards to the way our headcount eventually has been coming off through the course of the last couple of quarters, and the whole IT services side has been declining for the last three quarters. So how should we be thinking about our optimization around the pyramid in the context of the fact that our headcount has been coming off for the last three quarters, alongside the utilization almost running close to the peak levels.

Harsh Soin

Okay. So, this is Harsh, and thank you for asking the question Manik. So if you noticed that our internal fulfillment rates have increased substantially. In fact, they have gone up to about 46% to about 71%. Clearly our focus as we stated in the last quarter also on us giving, giving opportunities for within has really worked out.

Now add to this the fact that our attrition is also the lowest in our peer set gives us a lot of confidence that the strategy is working and folks are getting more opportunities internally. So we don’t have to go out for every single vacancy. I think that’s a good sign for the organization going forward.

Manik Taneja

Sure. Thank you. And if I can ask one more, given the fact that we expect first half to be selectively subdued, should we expect the deal pipe, the deal win number also [inaudible] typical deals that we have targeted.

Rohit Anand

Well, we won’t give a guidance Manik, that’s clearly a number, but I think from an overall year perspective you’ll be able to look to that. And Manish added to the comment that the discussions are quite favorable and encouraging, and hence from a yearly basis, to look at the year versus last year, we feel that as it moves today and what the quality of those discussions are, we should not be far off and maybe we’re not.

Manik Taneja

Sure. Thank you and all the best for the future.

Operator

Thank you. That was the last question for today. I would like to hand the conference over to Mr. Rohit Anand for closing comments.

Rohit Anand

Thank you. I just want to reiterate that we, as a company, we will – as we’ve committed in the past, we’ll continue to drive towards the goal of driving productivity. We will continue to expand margins that we’ve communicated to you. We will continue to provide return to shareholders. We’ve returned back INR50 share this year, and which is a 11% expansion from last year. [Cross Talk].

CP Gurnani

So Rohit, I just want to add.

Rohit Anand

So as a company, continue to our goals of driving growth, margin improvement from where we are today, and then capital returns. So with that, we’ll move into the next year with those goals in our mind and thank everybody for joining us for today’s call. Thank you.

Manish Vyas

Rohit, CP wanted to say something.

CP Gurnani

So Rohit, I just wanted to reassure all the analysts and investors that the company is conscious of some of the macro challenges, but I think we are in a better position to address some of these challenges. And that old saying that opportunities are best discovered during the crisis and the company is geared up to take advantage of the crisis. Thank you so much. Thanks everybody.

Rohit Anand

Thank you.

Operator

On behalf of Tech Mahindra Limited, we conclude this conference. Thank you for joining us and you may now disconnect your lines.