Will Indian IT companies continue to outpace expectations?

Is the second wave going to give a second chance to the bulls of Dalal Street?

Amidst the flurry of rising cases, potential shortage of vaccines, COVID-inappropriate behaviour by a large number of citizens, the markets have been extremely choppy these days. As far as businesses are concerned, the tiny creature isn’t unkind to all.

Ever since the coronavirus pandemic has rocked the world upside down, digital adoption has zoomed, resulting in technology companies making fortunes, globally. Some are calling them islands of growth while others are terming them torchbearers of the post-pandemic era.

When defensives take the front seat in earnings recovery, markets have no option but to take note and account for the change.

In the Indian context, leading IT companies are largely export driven and qualify to be in the league of defensives, historically, thanks to their sound business models, high revenue visibility, structurally low-leveraged balance sheets and so on.

Over the last one year, Indian IT stocks got majorly re-rated, which reflects in their current Price-to-Earnings (P/E) ratios quoting at a significant premium to their 5-year median P/Es.

What’s in store for IT companies?

Market price is the closing price as on April 12, 2021
P/E, sales growth and net profit margins are Bloomberg consensus estimates
(Source: Bloomberg, BSE)

Markets have been expecting stellar numbers from leading IT companies over the next few years as well. The companies expecting to clock a higher sales growth and the ones enjoying better net margins have attracted premium multiples.  

Thus, companies posting better than expected quarterly performance may continue to remain in the limelight.

Tracking quarterly performance is crucial

TCS kickstarted the Q4FY21 earnings season and reported impressive numbers. Its profit grew 14.9% Year-on-Year (Y-o-Y) and 6.2% Quarter on Quarter (Q-o-Q).  Despite the upbeat commentary by the TCS management, the initial reaction of the stock market hasn’t been encouraging.

On this backdrop it is interesting to see how other leading IT companies perform.

Our technical experts see a 30%-45% upside potential (over the recommended price) in two IT companies—Tech Mahindra and Tata Elxsi. Recently we discussed these two companies in a video series—Stock talk with BKG—which focuses on momentum stock ideas.

What to watch out for in Tech Mahindra’s results?

• In Q3FY21, Tech Mahindra reported 19.6% EBITDA growth, which was the highest number in the last 24 quarters. Will it carry the same momentum in Q4FY21?
• On the deal front, the company had offered a bullish guidance.  In Q3FY21, Tech Mahindra reported a net new deal inflow of USD 455 million. New deal wins and the commentary on the pipeline of deals remains crucial.  
• The company has been eyeing more large value deals (upwards of USD 50 million each) for quite a while now. Its progress on this front remains a key monitorable.  
• Besides growing the share of 5G component as a percentage of network business, the company has been gearing up to grab a piece of the EV market pie by catering to niche areas. Any further elaboration on this topic will be meaningful for investors.

Top 20 clients account for 31% of Tech Mahindra’s top line and 94% of its clients give repeated business; thereby indicating low revenue concentration and higher customer satisfaction. Tech Mahindra’s investments in R&D, product development and platforms, as new service offerings, are likely to fetch good results in future.

Factors to watch out for in Tata Elxsi numbers

The company had reported a quarterly PAT of over Rs 100 crore for the first time in Q3FY21. In a conference call post earnings, it had indicated that it would carry this momentum in the coming quarters.

• The company has been cautiously moving away from a project-based business model to a more long-term sustainable engagement model. In its long term strategy, media and communication, and the healthcare domain are expected to offer a substantial diversification, which will enable the company cut back its heavy reliance on the automotive industry. Thus, it will be important to monitor the growth rate of the other two verticals, over the next few quarters.
• Broadly, the management strategy has been to cross-sell designs and design-led engagements to the existing customers. It will be important to see the company’s progress on this front in Q4FY21.
• Historically, the contribution of offshore revenues in the top line has been 50%-55%. In recent times, it’s gone up to 67%-68%. The company has been expecting the mix of offshore vs onshore to remain in this range even in future. A quick follow up on this topic would help gauge the texture of profitability.
• At 30% in Q3FY21, the EBITDA margins of Tata Elxsi were way above the target rage in of 22%-24%. The margins in the last quarter were boosted chiefly because of a fall in travel and visa related expenses. It will be interesting to see if the company continues to operate at similar margins this time around as well.
• Tata Elxsi has hinted at announcing a revised capital allocation strategy along with Q4FY21 results. It would be crucial to see how much capital the company deploys to the stated growth areas.  
• The company has been appraising the potential to add more verticals to the revenue stream, not in a hurry though. In the past the management hinted at off-road and railways. Any commentary on this front would be a worth taking note of, from the perspective of further developments.

Tata Elxsi and Tech Mahindra are expected to declare their results on April 22, 2021 and April 26, 2021, respectively.

In a nutshell

Markets have lots of expectations from IT companies in Q4FY21 and beyond. It’s difficult to estimate how much of the good news is already in prices. Thus, instead of following your conviction, it’s far better to listen to the markets and keep a hawk’s eye on fundamental developments.   

Please note (read as a disclaimer): The blog is for information purposes only and anything mentioned herein shouldn’t be construed as a fundamental reason to buy/hold/sell any stock. Furthermore, the information provided in the blog and observations made therefrom shouldn’t be treated as the extension of recommendations made on the other properties of Ventura Securities.

 If you are following any of Ventura Securities’ fundamental or technical recommendations, please take a note of crucial price levels as well as the key factors, if any, highlighted in the respective reports/videos/infographics or any other form of communication used to disseminate the recommendation/call. We strongly suggest you to consult your financial advisor before taking any decision pertaining to your finances.  

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Disclaimer:

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.