Investors’ expectations from Tata Consultancy Services Ltd (TCS) have been running high. The company is now valued at 20 times estimated earnings for the current fiscal year, a significant premium to competitors such as Infosys Ltd and HCL Technologies Ltd.
Even so, for the past three quarters, the company has managed to either meet or beat Street expectations. In the June quarter, TCS did better than most analysts’ estimates. Revenue grew by 4.1% sequentially to $3.165 billion, higher than consensus estimates of 3.5% growth. Importantly, this was despite a 5% drop in the India business, which fell from a high base in the March quarter. The international business grew 5.8% in constant currency terms. Overall volume grew by over 6%.
As analysts at CLSA Research have been pointing out since the March quarter, TCS is in the mid of an acceleration in revenues—for three consecutive quarters now, its incremental revenues have been 50% (or more) higher than the incremental revenue growth in the year-ago quarter. Last quarter, incremental revenues stood at $125 million, compared with $80 million in the year-ago June quarter. What’s more, the company’s commentary and deal signings remain strong. TCS now also stands out as the only company to state that demand for discretionary projects is robust, backing it up with strong growth in its consulting business and enterprise solutions segment last quarter.
While this is at odds with the trends that came out from results of Accenture Plc and Oracle Corp., investors will be enthused that TCS’s strong commentary is backed by strong results. The company’s revenue grew by 16% year-on-year (y-o-y), which is well over Nasscom’s yearly growth target of 12-14%.
Profit margins came off by about 45 basis points sequentially after adjusting for a one-off expense in the March quarter but this is understandable keeping in mind the wage hikes that were made last quarter.
The only chink in the company’s armour seems to be a drop in cash conversion. While net income rose by 11.9% year-on-year last quarter to $683.2 million, free cash flow fell by 36.5% to $234 million. This is probably because of an increase in the proportion of revenues from longer-gestation projects (such as in the infrastructure segment), where the receivable cycle is higher. Of course, it remains to be seen if the decline in cash conversion is a one-off event—after all, cash conversion was quite strong in the preceding two quarters.
The other little worry with the results is the relatively low hiring. While the company has said that its revenues will grow faster this year compared with the growth rate in the previous year, its hiring numbers were lower on an year-on-year basis. But again, hiring last year was higher than the underlying requirement back then, and the company’s bench should strengthen from the second quarter onwards. Also, in the current environment, it’s relatively easier to hire on a just-in-time basis.
All told, investors will be pleased with TCS’s performance, and the company’s commentary suggests that growth should be robust in the rest of the year as well. However, given where valuations are, gains should be restricted.
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