TCS Q2 earnings: Five things to watch for today

TC is likely to report weak numbers in the second quarter and risks growing at a slower clip this year than last year

Natarajan Chandrasekaran, chief executive of Tata Consultancy Services (TCS). Photo: Bloomberg
Natarajan Chandrasekaran, chief executive of Tata Consultancy Services (TCS). Photo: Bloomberg

Bengaluru: Tata Group chairman Cyrus Mistry has a new worry in the growing pile of troubles afflicting India’s largest conglomerate. How to revive growth at Tata Consultancy Services Ltd (TCS), which accounts for 16% of the group’s $103.5 billion revenue?

The troubles at Tata Motors Ltd and Tata Steel Ltd are well-documented. Despite TCS reporting a 3.7% sequential dollar revenue growth in the April-June period, the company is likely to report weak numbers in the second quarter, results of which will be declared on 13 October.

Worryingly for investors, TCS now risks growing at a slower clip this year than last year, when its revenue expanded 7.1%, the slowest annual growth at TCS since 2009, when Natarajan Chandrasekaran took charge as its chief executive.

TCS is expected to report an at-best 1.6% sequential dollar growth in the second quarter, according to brokerage BNP Paribas. This, on the back of 3.7% growth in the first quarter, translates into TCS doing $8.79 billion business in the first six months of the current financial year.

TCS now needs more than $8.92 billion in revenue in second half of the year if it intends to grow at 7.1% this year. Simply put, TCS will need to record a better show in the October-March period this year than in the second half of last year. This certainly is a tall task as technology outsourcing firms report soft growth in the second half of the financial year.

Undoubtedly, Chandrasekaran faces a tough task given the size of TCS.

At the heart of TCS’s slow growth is its inability to build a stronger consulting practice and reluctance to buy small firms for technologies like design consulting and automation platform providers.

These tiny buyouts not just improve the current solution deliveries but also bring in growth. May be now, Mistry could nudge Chandrasekaran to start buying.

With this as a backdrop, Mint puts the spotlight on five things to watch in TCS’s second quarter earnings on 13 October:

1. Revenue growth

Brokerage BNP Paribas expects TCS’s dollar revenue to rise 1.6% to $4.43 billion in the July-September period on a sequential basis. This is a big worry as this will mean that TCS needs to put forward its best foot forward in the remaining six months of the year if it wants to save itself from the humiliation of recording an even slower growth than last year.

Management commentary on demand levels from its customers in Europe, after Britain voted to leave the EU, will be crucial.

2. Pressure on profitability poses a double whammy

Since January this year, TCS’s operating margins have been under pressure. TCS’s 26.1% Ebit (earnings before interest and tax) margin at the end of March quarter was 54 basis points less than margins at the end of October-December period last year. The company’s margins further contracted to 25.1% at the end of March quarter, which the management claimed to be largely on account of annual wage hikes.

Now, as commoditized deals come under further pricing pressure, and TCS continues to spend money in reskilling its workforce and building digital technologies, traditional levers like going slow on hiring, will not be enough to offset the gradual decline in profitability.

Analysts say that TCS is unlikely to end the current financial year with its stated guidance of 26-28%.

3. What really is the problem among TCS’s BFSI clients in the US?

On 7 September, TCS in a mid-quarter update, said that “some holding back of discretionary spending particularly in the BFSI (banking, financial services and insurance clients) vertical in the United States” had led to “sequential loss of momentum” at the company. Is this just an one-off development or does this suggest a structural malaise? We know all IT vendors are seeing less business from big banks as these banks are spending less in application development work. Homegrown technology vendors are further seeing erosion in current revenue from the embrace of automation platforms, which is cannibalizing the existing model of billing clients on human hours.

4. Rain check of weak sectors and geographies

TCS does not expect growth to rebound in Japan. The company claims to have arrested any loss of business from its UK-based insurance platform Diligenta. Growth from telecoms segment continue to be wobbly. Together, an underperformance from the three units eroded about 2% growth from the company’s 11.9% growth on constant currency basis in 2015-16. TCS needs to report some growth on a consistent basis if it has to better last year’s growth.

5. Is higher net erosion of existing business biting into TCS’s growth?

During the July-September period last year, TCS claimed its order book was the strongest ever, with about 30% more than the company ever managed in any quarter. The company, however, does not disclose its order book size. Outsourcing deals are long-term contracts, and IT vendors can generate only about 3-4% of revenue from new orders in the first year, according to JPMorgan Chase’s George. Agreed, IT firms lose about 3-5% of current business every year, which in TCS’s case, translates into a loss of about $500-825 million a year. This clearly suggest that TCS is losing more business from existing clients because even some business generated from its record order book has not offset the annual loss of business, thereby resulting in a sluggish y-o-y growth.

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