Growth story continues; Tweaked estimates, Reduced PO

Post in line 1Q results, we retain our Buy on Tech Mahindra Ltd (TML) with a revised PO of Rs 1940, potential upside of 31% from current levels. We have tweaked our estimates by 4-5% for FY08/FY09e to factor slower revenue growth in 1QFY08. We expect the strong traction in BT, AT&T and other key accounts to drive earnings CAGR of 41% during FY07-09E on ML adjusted basis (factoring 5- year write-off of upfront payment to BT, though TML has written off fully).

Commentary on BT Global Services encouraging

Management reiterated its stance of a “J “curve recovery in the BT Global Services deal and appeared confident of strong growth from 3Q FY08 onwards. It currently has a 50-member transition team in place and has already identified around 800 positions which could be offshored to TML.

In-line margin decline, likely to expand

Operating margins declined by 330bps largely driven by salary hike, appreciating rupee and cost buildup in the BTGS deal. We expect margins to expand by 350bps over the next 4-6 quarters, driven by revenue growth in the BTGS deal and increasing utilization levels. Management intends to shore up utilization levels by over 500bps to 75% over the next 1-2 years.

Maintain Buy; Strong 41% EPSg over next two years

Our PO of Rs1940 is at 1PEG (FY07PE to FY07-09e) and implies a target FY09P/E of 21x on ML Adjusted EPS of Rs 94. We believe this is fair given sharp anticipated earnings growth of 41% (FY07-09e), robust IT spends by telecom service providers and increasing trend in offshoring.

Price objective basis & risk

Our PO of Rs1940 is at 1PEG (FY07PE to FY07-09e) and implies a target P/E of 21x on ML Adjusted EPS basis of Rs 94 and at a discount to peers such as Infosy (23x FY09e). We believe this is fair given sharp anticipated earnings growth of 41% (FY07-09e), robust IT spends by telecom service providers and the increasing trend in offshoring. Risks to our rating are rapid growth-related execution risks, high vertical (telecom) and client concentration (BT- 64% revenue). Industry-wide risks include growing competition, wage and attrition pressures and risk of rupee appreciation.