Winds of Change at Tech Mahindra
There is a lot of buzz around leadership change at IT services company Tech Mahindra Ltd. The term of current general manager (MD) and chief executive officer (CEO) CP Gurnani expires in December. Investors were hoping for an announcement regarding the new CEO at Tech Mahindra’s Investor Day on March 3. Ahead of the meeting, the stock was up 9% over the past month. But those hopes were dashed because management did not clarify this.
There is plenty of speculation about whether an internal or external candidate would take the lead as the next CEO. At the Investor Day meeting, management indicated that there will be a reasonable transition period between Gurnani and the succeeding CEO. Tech Mahindra’s growth strategies are unlikely to change significantly as a result of a change in leadership, as these strategies are based on input from key customers, management added.
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But this needs to be followed more closely. “When a new CEO comes along, growth strategies tend to change. In this case, if the incoming CEO is conservative in his approach, the Street may not like it given Tech Mahindra’s continued relative underperformance against peers,” said an analyst who asked for anonymity.
Meanwhile, Tech Mahindra aims to scale its products and platform business from its current run rate of $450 million to about $1 billion over the next three years. The management is also not looking for major acquisitions and strives for organic growth. While the company did not share an incremental outlook for FY24 revenue growth or margin, levers such as lower subcontracting costs and offshore improvement should benefit margins in FY24. But with recession risks looming, potential downside risks to earnings growth should not be overlooked. “We think Tech Mahindra’s increased exposure to stressed verticals (Telecom + Hi-Tech, 50% of revenue) is likely to weigh on growth in FY24. Lower growth will also prolong margin convergence,” says a report from JM Financial Institutional Securities Ltd.
In recent quarters, Tech Mahindra’s earnings performance compared to peers has been unimpressive.
Tech Mahindra’s margin profile has historically been weaker than that of Tier-1 Indian IT companies, according to a report by Nomura Financial Advisory and Securities (India) Pvt. Ltd. This is due to structural reasons, including low levels of offshoring and greater reliance on subcontractors, Nomura added.
Tech Mahindra’s Ebit margin for the nine months ended December was 11.5% versus 14.6% in FY22. A recovery to FY22 levels is likely to be a gradual and multi-year journey, the analysts added.
Investors have taken note. Over the past year, shares of Tech Mahindra are down about 25%, while shares of most Tier-1 IT companies have fallen at a slower pace.
While the leadership change is a critical trigger for the stock, a meaningful rebound would depend on the pace at which the company is able to bridge the earnings growth gap with competitors. “We believe any change in management can, at best, provide a temporary boost to the stock,” Nuvama Research said in a report. After that, price movement would be driven by the earnings growth trajectory, which would take time to bounce back given the structural changes the company needs to compete with peers, the report said.
Valuations are not demanding. Data from Bloomberg shows Tech Mahindra stock is trading at a price-to-earnings ratio of 16x in FY24 at a discount to its peers. Those aiming for a quick upturn in Tech Mahindra’s earnings performance may be in for a disappointment
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