Tech Mahindra Ltd

NSE:TECHM

Earnings Call Transcript 2023-Q4

[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 a listen-only mode. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. C.P. Gurnani, MD and CEO for Tech Mahindra. Thank you, and over to you, sir.

[C. Gurnani, executive]

Thank you. Good evening, everyone, I am really happy about 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. And also, very happy particularly, despite of all the challenges, has continued to grow for 12 quarters in a row.On the enterprise side, we have touched a $1 billion quarterly run rate which means really a billion-dollar businesses have been built in BFSI and manufacturing. And also very happy that the technology investments or upskilling investments your company has made on quantum computing, Metaverse, on blockchain, 3.0 cloud, and the customer experience management are yielding good results.We continue to be given to make our customers successful and we do believe that while the global economic outlook continues to be a 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, gives 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 taken as a company has always believed that never waste a crisis. And we would like to double up our investment in people upskilling.We want to double up our investment in technology. We want to develop our investment in practicing a few markets like Japan or Middle East because we generally believe that there will be more deals because our clients will eventually want to move to new platforms, would want to move 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 have been under pressured but as I said, if you look at investments, if you 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 line and in AI. We are looking at predictive technologies, data scientists, cloud, in a much bigger way. So my belief is, as we adopt it 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, large deal is at $592 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 hesitancy right now, but they are 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 the Board has agreed to a recommendation of final dividend and the total dividend now becomes INR 50 for the year. So I again want to repeat that, to me, the soft environment is an opportunity and take mind we geared for that opportunity through our own investments in 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 engineers for both growth and profitability. I'm joined with my colleagues, Manish Vyas, Jagdish Mitra, Vivek Agrawal, Harsh Soin, CTL. So we will have a free-flowing debate, but therefore, 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, executive]

Thank you, CP. Good evening to everyone. Let me now cover the company financials for the fourth quarter and the year ended 31st March 2023. We ended Q4 with a revenue of $1,668 million, marginally up compared to Q3 constant currency. CME vertical grew 1.8% Q-o-Q on a C3 basis. Our enterprise vertical decreased by 0.7%.Our deal wins were at $592 million for the quarter. The revenue in repeat terms was about INR 13,718 crores versus INR 13,735 crores in Q3, down 0.1% Q-o-Q. 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. SG&A PAT 90 basis points. And these were offset by productivity actions that we had articulated in the past that we've been working on, namely around score reduction, which gave us a tailwind of 70 basis points.Moving over to EBIT, other income for the quarter was $37 million. We had a ForEx loss of $1 million compared to a gain of $15 million in Q3. There was a one-off impairment cost of $26 million in Q4, which was reported in the financials this quarter. We continue to follow from an FX perspective of rule-based hedging policy, which has helped us deliver good results over a long-term 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 have said before, our normalized ETR for the year is in the range of 25% to 26%. So that continues to be the bank. So our net profit margin for the quarter was 8.2%, a decrease of 120 basis points versus Q3. Free cash flow was $142 million, which was 104% of PAT. Our DSOs have reduced by 2 days to 96 Q4 versus 98 in Q3.Moving on to the full year performance. Our revenue stood at $6,607 million with a constant currency growth of 30.7%. In rupee terms, our revenue was INR 533 billion, with yearly growth of 19.4%. During the year, communication business grew as a bench 30.4% and enterprise grew 3.9% in CC terms within enterprise technology, retail, and manufacturing for the major growth travels for the year.We ended the year with an EBITDA of $990 million and EBITDA margin of 15.1%. The EBIT for the full year was $747 million, and an EBIT target stood at 11.4% versus 14.5% in FY '22. This decline of probably 300 basis points was driven by headwinds due to registration that we saw on the supply side, more aggregated towards the first few quarters versus the last quarter. SG&A travel costs with selling normalization post-COVID, increasing year-on-year. Some of the deal EBITDA related costs that we had articulated before, around 50 basis points. And then the large deal cost, where the ideation over a large deal reduces and the recovery of the efficiency happens in late years. So that was around 70 basis points.The offset for the year were 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 deliver close to that number. So our sub cost perspective has had a reduction to help that has contributed 80 basis points. And then we continue to drive more offshoring that has helped us give a benefit of 30 basis points.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 $2,335 million with a mark-to-market gain on outstanding cover as of 31st March 2023 being $13 million. Based on the hard accounting treatment of the head of $4 million is being taken to the P&L and $8.9 million residual in quarter reserves.Free cash flow for the year was $497 million, which was 84% of PAT conversion. DSO year-on-year went down 1 day. Cash and cash equivalent at the year-end stood at $905 million and in INR terms, INR 7,435 crores. In line with our commitment to prudent capital allocation that CP articulated, we continue to return cash to shareholders. The Board, after our recommendation, has approved of a INR 32 per share, taking the total dividend for FY '23 to INR 50 per share, which is an expansion from last year by close to 11% from INR 45 per share. This translates to a dividend payout ratio of 91% for FY '23.And in summary, I would like to reiterate execution strategies focused on portfolio synergy, operating rigor, and people transformation as we move into the next fiscals. With this commentary, I will open the floor to questions and with all the leadership team, we'll take each question by the other.

[Operator]

We will now begin the question-and-answer session. [Operator Instructions] Ladies and gentlemen, we will wait for a moment while the question queue assembles. The first question is from the line of Abhishek Bhandari from Nomura. Please go ahead.

[Abhishek Bhandari, analyst]

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 in Q4. And if I look at your commentary since the start of the year and also in your analyst meet, the visibility on you recovering back to the FY '22 margin towards FY 2016 seems to be very heavy. If you could help us understand, how should we think about margin expansion from here and Q4, particularly the SG&A, what happened?

[Rohit Anand, executive]

Yes. So, from an SG&A perspective, maybe to start of Q4 for us. With from an investment perspective, we continue to invest more in terms of 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 cost, which was trued up and then that will get normalized as we move into the next year. I think our view is that GN as a percentage of revenue should be in the bank of around 13.5% for us, that should get normalized.When you look at future view in terms of margin, right, as we move from here. I think as I 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 subcon will be something that we'll keep on working on that you see the margin reduction there. We will continue to work on form file levers that we said earlier. I think our large deals will 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.Second, we had articulated. We still have almost 4% to 5% improvement opportunity in our offshoring rate versus India today. So that we'll continue to drive. We also said that we'll continue to drive pyramid rationalization, and that's an investment we are going to break in FY '24. So that's the lever we'll continue. We also said that we will take some structural action to Paris or stop at a sub profitable or low profitable business. So we did some actions last year have been continued to execute the pipeline we have to expand margins on that front as well.And then with this, of course, well, while we continue to reduce it will also drive better margin expense by improving the mix. So those are a few actions that we will continue to drive as we move forward. And I think directionally, our commentaries are the same that we have more opportunities to continue to expand it. Obviously, the macro environment in last two quarters and as we look at the next two quarters, is relatively different than what we've seen in the beginning of the year. And then our view is, as we move into the second half, it will really get better again to where we were. So in terms of Q1 macro first half will be more cautious versus the second half.

[Abhishek Bhandari, analyst]

So if I can understand this correctly, the margin improvement for FY '24 is contingent on a better second half of FY '24?

[Rohit Anand, executive]

I would say margin improvement would be irrespective target or view that we will go for. But when we look at our demand scenario in our overall macro environment vis-a-vis the verticals and all the mix that we have. From a view perspective, second half in our view, get better than maybe and so. That's not the basis on which we will drive our margin action.

[Abhishek Bhandari, analyst]

Okay. Thanks, Rohit, for that. The second and final question is on your Top 5 client outlook. While you had already kind of signaled it into last quarter that the Top 5 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, executive]

I think, as I mentioned, it is bottoming out at the peak, there are certain plus and minus there. But generally, the trend seems to be stabilized. And as we move forward, while I can't share any customer-specific information, but we've had a majority of the impact and should be towards the back end of that.

[Abhishek Bhandari, analyst]

Okay. Thank you, Rohit, and all the best for FY '24.

[Operator]

Thank you. [Operator Instructions] The next question is from the line of Sandeep Shah from Equirus Securities.

[Sandeep Shah, analyst]

Thanks for the opportunity. This is a second quarter in a row where constant currency growth is almost like a flat edge. And 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 to continue to remain tepid in the first half despite you believe the Top 5 client specific issues are largely getting behind? So how do you expect there would be a growth bump up from the last two quarters in the first half itself? Or you specifically the first half would be cautious and growth revival would be only in the second half?

[Rohit Anand, executive]

Yes. Thanks, Sandeep, for the question. Yes, I mean, as I mentioned, while I won't give a number of the 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 site that then, in our view, and looking at our mix customer verticals online argue with that trend continues in some form or shape for the first half. The pipeline is still robust right across the segment.There are good deal discussions happening. There's a mix change in terms of deal dynamics also. But from a pipeline discussion, perspective is quite favorable overall. But the trend wise, yes, first half versus second half is kind of a reverse mirror reflection of what we've done last year at the end of the currency. And as we move forward, we'll keep on updating you on what changes are we seeing across industries, vertical, and geography. But I can also request, Manish is here, and they can add some flavor on their side of the business to give you a perspective of the –

[Manish Vyas, executive]

Thank you, Rohit. I think I'll just add that the broad sentiment continues to remain at the investments from a tech standpoint. It remains a top priority for most of the customers that we talk to, either it is to find operational efficiencies are to continue to modernize. What place 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 -- 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 more certain, the second half of the fiscal, I think we'll start seeing the positive upswing and some of the large deals that we are pursuing now as some of them have got delayed from a decision standpoint, they nevertheless remain extremely important for each of these customers to decide at some point. It could be a month; it could be sometimes more than 4 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, too.

[Sandeep Shah, analyst]

Yes. And commentary on enterprise?

[Jagdish Mitra, executive]

Jagdish here, Sandeep. Thank you. I've been 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 at different levels. So even cost breakout is ultimately leveraging leadtech technology, which CP talked about that we've invested in, and we start we are starting to see a lot of engagement on that, whether it's AI, whether it's data analytics, whether it's some of the work that you're doing in quantum, et cetera.Pretty similar to what Manish said, decision-making is going to be prolonged. People will look at it multiple few times. But the conversations are there and obviously, the more the discussion is to cost takeout related deals that and transforming their core functions, whether it's supply chain, whether it's back-office operations, and so on and so forth. And it's pretty uniform across enterprises, industry verticals; some a little more than the other, but more or less, the good part of it is the tech conversations and the transformation conversations continue. So confident and bullish that the transformation gain is definitely not slowing down.

[Sandeep Shah, analyst]

Okay. And just a follow-up in this outlook for growth, which may be taken 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 this?

[Harshvendra Soin, executive]

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

[Sandeep Shah, analyst]

So it would be across four quarters of FY '22.

[Harshvendra Soin, executive]

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

[Sandeep Shah, analyst]

Okay. Thanks.

[Operator]

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

[Sudheer Guntupalli, analyst]

Thanks for the opportunity. One of our competitors saw a sharp decline in communications. And thereafter, the expectation is that we should see a sharper impact given our concentrated exposure to this vertical and some of our top clients are from this vertical. However, your performance in communications is fairly blunt –

[C. Gurnani, executive]

Sorry, what is the question?

[Sudheer Guntupalli, analyst]

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

[C. Gurnani, executive]

I think on the contrary, I think you heard in the opening comments, and I think I have also been saying it for some time. We've actually seen a consistent growth in the telecom vertical now for the last 3 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 3rd of March that we should be getting to close to $1 billion run rate as far as our 5G business is concerned, as you know, we invested mostly organically in capability 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 the that billion number that we, from a run rate standpoint, that we have had.The other very interesting and important, I'm sure all of you would recall that back in the day in 2015, I mean I'm taking 8 years back, we did invest in LCC and that did play out that well at the time. But we have been consistent in saying that our commitment as a technology agnostic independent integrator and managed service providers to the networks, both carrier and enterprise network. I think it's a huge differentiator for your company. 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 when our network business is comp -- so where are -- 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 the we've got a single telecom service provider in every market that we want to operate in that we do not serve today.So now granted that 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 will be third quarter or fourth. But I definitely can say this that from a midterm to long-term standpoint, the discussions that we are having with this sector are absolutely all time best. And I don't think we need to be concerned about that.

[Sudheer Guntupalli, analyst]

Okay. Thanks, that's very encouraging.

[Operator]

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

[Girish Pai, analyst]

You mentioned that there's probably a pickup in growth into etch. What is the optimism based on? Is it based on some client conversations you've had? Or is it like nearly hope?

[C. Gurnani, executive]

So maybe, overall, I said that the pipeline is quite robust from where we were last year. So I think that is first, hope, if you will. Second is client conversation, which Manish just mentioned, which is what I'm saying that is quite positive. There is a slowdown in terms of decision making, which is what we were saying that there are more approval cycles and hence the final sign-off is taking time, which is what we're kind of cautioning out from a first half perspective, we will continue what we've seen in the second half of this year.But from an industry perspective, if you look at cloud penetration still low. In communication, the 5G penetration is still a lot to desire for and AI work isn't 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 is positive. So 1, 2, or 3 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 discussions we've had. And maybe some of them are that Manish, maybe you can elaborate some examples.

[Manish Vyas, executive]

I think the only thing I would add to this, and we may have mentioned this earlier, this is not the first time the story is playing out in this tech industry. Well, we have seen these pressure points and the decision that typically get made are around modernization, around transformation, around cost takeout, and those conversations have begun. Now I like to say we can't really predict whether these decisions will happen in 6 months or 8, but they will happen at some point in time, and that's when. So I think it's also not a function of hope, but definitely a function of the business that we have at this point in our conversation. If that answers your question.

[Girish Pai, analyst]

Yes, thanks. Just one last one. What's your view on pricing in FY '24? I believe you did get some price increase in FY '23. How are you looking at that in '24?

[C. Gurnani, executive]

We'll have some carryforward impact from last year to this year. That will flow through of the impact of Q2, Q3, Q4. But incrementally, while we'll continue to drive those conversations where our opportunity on where we should be versus where we are is there. But on a broad-based perspective versus last year is 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 tend to be very close to defining how they look at future and hence, positioning ourselves on driving efficiency outcomes for 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's kind of what we drive pricing of the lever is going to be limited this year versus last.

[Girish Pai, analyst]

Okay. Thank you.

[Operator]

Thank you. The next question is from the line of Manik Taneja from Axis Capital.

[Manik Taneja, analyst]

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

[Harshvendra Soin, executive]

So this is Harsh and thank you for asking this question, Manik. So if you notice that our internal fulfillment rates have increased substantially. In fact, we have gone up to perform about 46% from about 31%. Clearly, our focus, as we stated in the last quarter also on upskilling, giving opportunities for within has really worked out. Now add to this the fact that our accretion 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 recently. I think that's a good sign for the organization going forward.

[Manik Taneja, analyst]

Sure. And if I can ask one more. Given the fact that you expect first half to be relatively subdued, should we expect that the deal type, the dividends, the number of residential remains static below the typical things that we are having?

[C. Gurnani, executive]

We don't give a guidance in that number, but -- so I think we will overall year prospectively, we look that. And Manish added to the comment that the discussions are quite favorable and encouraging. And so, to look at the year versus last year, we feel that we added moves today and what the quality of those discussions are, we should not be far off from maybe [indiscernible].

[Manik Taneja, analyst]

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, executive]

Thank you. I just want to reiterate that we, as a company, 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 have communicated to you. We will continue to provide return to shareholders. We returned back INR 50 per share this year and which is 11% expecting --

[C. Gurnani, executive]

Rohit, I just wanted to add –

[Rohit Anand, executive]

– policy. So as a company, just continue our goals of driving growth, margin improvement from where we are today and then capital reserves. So with that, we'll move into the next goal in our mind and thanks everybody for joining us for today's call. Thank you.

[Jagdish Mitra, executive]

[indiscernible] wanted to say something, I think.

[C. Gurnani, executive]

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 the world is saying that opportunities have been discovered during the crisis and the company is geared up to take advantage of the crisis. Thank you so much. Thanks, everybody.

[Operator]

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