Markets
Selective vision for TCS investors?
Summary
The information technology (IT) bellwether’s sequential constant currency (CC) growth was flat. The rising caution among clients led to deferment of discretionary technology spending, hurting revenue growth.Tata Consultancy Services Ltd (TCS)’s results for the June quarter (Q1FY24) broadly met the Street’s low expectations. The information technology (IT) bellwether’s sequential constant currency (CC) growth was flat. The rising caution among clients led to deferment of discretionary technology spending, hurting revenue growth.
Unfortunately, the management’s commentary does not offer meaningful clues on what lies ahead, at least in near term. Clients are scrutinizing return on investments in existing projects and deferring or cancelling those with lower returns, management told analysts. Within segments, banking, financial services, and insurance (BFSI); communications and hi-tech verticals continued a lacklustre performance.
Ebit margin came in at 23.2%, down 130 basis points sequentially and a tad lower than consensus expectations of 23.5%. Margins were impacted by wage hikes, which was partially offset by reduction in sub-contracting costs, the management added. The management said impact of wage hikes was largely behind, so margins are poised to imp-rove ahead. However, it did not share any guidance for FY24.
“Utilisation, realization improvem-ent and discretionary spend cutbacks were indicated to be key levers for margin improvement," said a Nirmal Bang Institutional Equities report. “The first two levers are a bit questionable in current weak demand environment. We think subcontracting cost, which has fallen to pre-pandemic level, will not be a key lever from here on," it added.
All said, scope for any material margin expansion appears limited in FY24. Interestingly, TCS’s shares were up 2.5% on Thursday. Investors seem to draw comfort from order inflows trajectory. TCS’s order book in Q1 stood at $10.2 billion despite the uncertain macro environment. Orderbook does not include the recently announced large BSNL deal.
A robust deal pipeline is a long-term positive and bodes well for revenue visibility and market share gains. “Large/mega deal pipeline is reasonably good in BFSI and telecom vertic-als where TCS has a fair chance of conversion," a Kotak Institutional Equities report said. But increasing competition for large or mega deals has made the task harder, the Kotak report added.
Little wonder then that some analysts are still not convinced about a meaningful turnaround in the company’s near-term earnings outlook. “Deal wins were steady at $10.2 billion, but are up just 4% year-on-year on the last twelve-month basis; not replicating Accenture outsourcing deal strength (up 22% year-on-year)," said a report by Ambit Capital. “Risks of growth versus margin trade-off as TCS has consistently underperformed Accenture (outsourcing)/Infosys over the last 14-15 quarters keeps us cautious," added the report.
Meanwhile, valuations of large-cap IT stocks have moderated lately. The TCS stock trades at 23.5 times estimated earnings for FY25, showed Bloomberg data .
“TCS’s subdued book-to-bill ratio, muted headcount addition and weak commentary does not inspire a revival in growth in the near-term," analysts at Jefferies India said. The research house pencils-in below-consensus expectation of 6% CAGR CC revenue growth over FY23-25 for TCS. “While TCS is better placed in a weak demand environment, its rich valuations leave limited upsides," it added.
To be sure, in the past one year, TCS’s shares have gained around 10% with the recession fears not materializing yet. The big question for investors now is whether the worst on the macro front is already behind us or lies ahead.
This will determine how FY25 outlook shapes up.
