Home >Markets >Mark To Market >TCS meets internal target in Q3; investors’ faith gets rewarded

Tata Consultancy Services Ltd, India’s leading IT services company, doesn’t give guidance like some of its peers. However, when some large tech companies suspended guidance in April, TCS stuck its neck out and said, “We are looking forward and modelling such that three quarters forward (Q3FY21) or four quarters forward (Q4FY21), we can get back to the same revenue and profitability levels that we are currently at."

Given the great uncertainty ahead, TCS’s target had seemed like a huge leap of faith. All the more so because it assumed a sharp recovery in the second half of the year, a period that has traditionally been weak in terms of IT demand.

However, TCS achieved its target. In Q3, the company returned to positive growth on a year-on-year (y-o-y) basis after two successive quarters of decline. Revenues rose 0.4% y-o-y in constant currency, against expectations of a decline of 1-1.5%.

Normalcy returning
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Normalcy returning

On a sequential basis, TCS reported its best-ever growth for the December quarter in nine years. Revenues rose 4.1% in constant currency quarter-on-quarter, unusually high for a seasonally weak quarter. Revenues in Q3 got a lift from deal wins in the earlier quarters. The company said adoption of digital and cloud services has accelerated because of the pandemic. It added that it sees this is a multi-year trend and not just a temporary phenomenon. The strong revenue growth and the upbeat commentary are likely to keep the stock buoyant when the market opens on Monday.

What’s more, despite the wage hikes in the last quarter, margins also rose about 40 basis points (bps) sequentially, to everyone’s surprise. Margins are now at year-ago levels, even after adjusting for the savings in travel costs. The street had expected margins to contract by 80-90bps because of the wage hikes.

TCS also increased its employee count by 15,000 last quarter. Despite all this, employee costs as a percentage of revenues fell by about 70bps. The company has stopped reporting metrics on utilization and on-site-offshore mix, but it seems an improvement in these measures helped margins, apart from the lift from higher revenues.

Large deal wins remained strong at $6.8 billion and growth in the near-term is expected to remain strong. The company said it will return to double-digit growth in the next fiscal. This will be off a relatively low base, but the bounceback of India’s IT companies has been remarkable. Earnings estimates for TCS in FY22 are expected to inch ahead of where they were about a year ago. The only quibble is that TCS remains behind Infosys Ltd in terms of y-o-y growth. The latter is expected to grow by 4-5% on a y-o-y basis.

Also, with valuations at over 31 times one-year forward earnings (compared to around 24 times a year ago), the TCS stock seems to be pricing in the revival and much more.

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