Techm may see re-rating as growth outlook improves

Increased focus on network upgrade and spending on 5G gear by telecom industry augurs well

As growth prospects of the IT sector improve, the stock of Tech Mahindra (Techm) has seen strong investor support in recent times.

With about 10 per cent rise over the last month, the Techm stock has been amongst the top gainers in the Nifty IT index, which is up just 0.4 per cent during this period.

An improved outlook with expectations of increase in spending in the telecommunication (telecom) space, including on 5G and other telecom infrastructure, is reviving investors’ interest in the stock, as around 40 per cent of Techm’s revenue comes from the telecom segment.

“Increasing need for rapid access to data and automation will enhance the focus on upgrading network equipment/technology and speeding up 5G network deployments. Telecom companies around the world are upgrading their network infrastructure, which will spur spending and Techm being an undisputed leader in telecom will be the prime beneficiary,” analysts at HDFC Securities said in a recent report.

Aniket Pande, analyst at Prabhudas Lilladher, says, “While 5G roll-out has got postponed due to the pandemic, 5G spending would sharply be expedited from FY22.”

Telstra — an Australian telecom giant, for example, is looking to extend its 5G network to 75 per cent of the population by next June from around 33 per cent at present.

Thus, Pande believes the increase in 5G spending will improve Techm’s valuation multiples.

Though with the recent rally, Techm stock’s 1-year forward price to earnings of around 16 times is 19 per cent higher than its 5-year mean, it is still at a 25 per cent discount to that of the Nifty IT index.

With muted 5G spending in the past few years, Techm was a laggard amongst top IT players.

Its revenue has increased by 6 per cent annually in the past three years compared to around 8-13 per cent growth clocked by other tier-1 peers, barring Wipro.

Techm’s Ebit (earnings before interest and tax) margin of 10.1 per cent in the June quarter is also the lowest amongst tier-1 players.

However, analysts believe that Techm's Ebit margin has now bottomed out and will improve going ahead, led by cost control initiatives. Other top five IT companies’ Ebit margins are over 17 per cent.

So, how fast the firm capitalises on opportunities in the telecom space and improves operating margin, reversing the past trend, will be crucial.