IT behemoths Tata Consultancy Services Ltd (TCS) and Infosys Ltd reported strong growth for the March quarter, clocking 2.4% and 2.1% sequential rises, respectively, in constant-currency revenue. The Street, at best, expected the companies to report a 2% growth.
The performance underscores strong execution and strong order inflows. Infosys signed large deals of $1.57 billion, taking the cumulative size of deals won to $6.28 billion for the full year. This is twice that of FY18. TCS also did well, bagging contracts of $6.2 billion last quarter, higher than the $5.9 billion of deals it secured in the December quarter.
The strong deal wins place both TCS and Infosys in a commanding spot for FY20. “Our order book is bigger than in the prior three quarters, and the deal pipeline is robust," said Rajesh Gopinathan, chief executive officer and managing director of TCS.
The commentary reinforces the belief that the growth momentum, which picked up in FY19 will continue in FY20. However, for investors looking for growth acceleration to justify further increases in the valuation of TCS and Infosys, the March quarter results provide limited levers.
The rising cost of business is increasingly undermining profitability. TCS’s operating margin contracted for the second straight quarter. It softened 30 basis points from a year ago to 25.1% in the fourth quarter of FY19. A basis point is 0.01%.
The impact is more pronounced at Infosys, which is behind in digital investments. Its operating margin dropped 3.2 percentage points from a year ago, to 21.5%. The continuing need for more investments means profitability could be suppressed in FY20 as well.
Infosys’s 7.5–9.5% constant-currency revenue-growth guidance for FY20 implies no significant acceleration from the year gone by. Its constant-currency revenue grew 9% in FY19. The company’s guidance may be conservative given the backdrop of its strong order book and guidance revision during FY19. However, it also underscores uneven recovery in its key business verticals.
Comparatively, key business segments at TCS have seen notable acceleration in growth rates from the year-ago quarter (Q4 of FY18). The better performance should help TCS maintain the valuation premium to Infosys. Nirmal Bang Institutional Equities estimates that the TCS stock trades at 22 times FY20 earnings estimates and Infosys, at 19 times. TCS’s valuation hinges on whether it can arrest the profitability erosion.
Investors need to be mindful of the softening business environment. Industry surveys show sluggish manufacturing activity in key markets of the US and Europe. Continued slowdown in the business environment could compel customers to delay execution, potentially delaying revenue accretion, warns Nirmal Bang Institutional Equities. How well these risks, macroeconomic and cost pressures, are managed will determine stock returns in FY20.