TCS is in a rut; it needs some imaginative leadership

Ahead of Tata Consultancy Services Ltd’s (TCS’s) June quarter results, its shares were building in acceleration in growth compared to the previous year and only a marginal moderation in margins, analysts at Nomura Research wrote in a note to clients.

The company disappointed on both counts. It reported sequential revenue growth of just 2% in a seasonally strong quarter, and its margins fell by 240 basis points. Operating profit was about 4% lower than analysts’ estimates, and this should result in a cut in earnings estimates for the year. A basis point is 0.01%.

As the chart above shows, TCS is in a rut, with growth slowing almost every passing quarter. With market conditions being really unfavourable, the company desperately needs some imaginative leadership to get out of this rut.

Based on the June quarter performance, the TCS stock can be expected to fall with a thud when trading resumes on Friday; although, of course, this outcome can’t be taken as a given, given the wonders strong liquidity can do to a stock’s valuations.

In fact, TCS shares have been fairly resilient despite all the negative news flow in the past year on growth, margins and visas. In the past one year, the company’s shares have been flat at around Rs2,400 each. This is despite a drop in revenue growth rates from around 10% a year ago to 6.3% in the June quarter, and a fall in trailing 12-month profit margins by nearly 100 basis points. Operating profit margins are now well below the company’s targeted profit margin range of between 26% and 28%.

Of course, the deterioration in the company’s performance isn’t entirely surprising, and as the chart shows, things have been going south for some time now. But after the June quarter results, there are concerns that the pace of deceleration is picking up. Analysts had already toned down expectations from the quarter thanks to TCS’s recent subdued commentary on the key banking and financial services sector. But growth as well as margins fell below even the low-key estimates.

And, almost as if in resignation, the company reported a net decline in its employee headcount, a first in over 30 quarters. To be fair, with growth slowing, and a reasonable buffer built last year on the employee front, there would have been room to extract some savings. But even so, TCS’s post-results commentary didn’t inspire any confidence.

There’s hardly anything exciting to look forward to—fast-growth segments account for less than a fifth of revenues and are too small to move the needle for the company as far as growth is concerned. Meanwhile, specialist firms with digital offerings are taking share away from traditional outsourcing companies such as TCS in this segment. There are a dozen other challenges such as a slowdown in overall IT spend, a continued shift by customers to captive outsourcing centres and restrictions on visas.

While it’s true that the market needs to revive for TCS to get out of this rut, as pointed earlier, what it also needs is some imaginative leadership.