TCS’ Q4 keeps IT investors in anguish

The deal pipeline remains strong and TCS is not seeing any issues in ramp ups, according to the management.
The deal pipeline remains strong and TCS is not seeing any issues in ramp ups, according to the management.

Summary

  • However, a bright spot was robust deal wins thanks to better traction across verticals and geographies.

Tata Consultancy Services Ltd’s (TCS) March quarter results (Q4FY24) do little to cheer up IT investors who continue to wait for meaningful signs of demand recovery. Sure, there were some bright spots. Firstly, deal wins were robust thanks to better traction across verticals and geographies. The total contract value (TCV) hit a record high of $13.2 billion in Q4 and $42.7 billion in FY24. This included a mega deal win of Aviva. The deal pipeline remains strong and it is not seeing any issues in ramp ups, according to the management.

Secondly, Ebit (earnings before interest and tax) margin expanded 100 basis points sequentially to 26%, ahead of analysts' expectations. One basis point is 0.01%. The sharp margin expansion was led by subcontracting costs sliding to multi-year lows and a reduced pace of hiring. Thus, partially offsetting the adverse impact of higher third-party costs and travel expenses during the quarter. The management has reiterated its medium-term Ebit margin target of 26-28%. Improving utilization, productivity and pricing are seen as the key margin levers.

Still, and more importantly, the question about the timeline of revenue recovery remains unanswered. TCS reported sequential constant currency revenue growth of 1.1%, slightly missing consensus expectations of 1.4%, amid slower decision making by clients and bleak demand scenario, but aided by ramp up of the BSNL deal. The performance of key revenue driving verticals of BFSI, hi-tech and telecom and developed markets of North America and continental Europe were sluggish in Q4FY24. While the management expects growth in FY25 to be better than FY24 aided by better execution of deal wins, it is cautious about near-term demand. Clients continue to re-prioritize expenditure on cost take out deals and projects with immediate return on investments.

Plus, the continuing lag between deal wins and revenue growth does not inspire confidence of a meaningful revival. Ambit Capital in a 13 April report cautions against extrapolating deal-flow positivity.

Further, in Q1FY25, margin may see adverse impact of high onsite costs, travel costs and wage hikes. TCS has given an average salary raise of 4.5-7%, with top performers getting a double-digit hike. Analysts at Jefferies India have raised TCS’ FY25-26 margin estimates by 40-90 bps to reflect better than expected Q4 margin and expect margins to be in the 25-25.4% range over FY25-27. However, they see limited room for margin expansion from here on. What’s more, subdued hiring and lower sub-contracting costs cuts both ways and while reducing costs it also points to weak demand outlook.

In this backdrop, some analysts have cut their earnings expectations for TCS. For instance, Ambit has further cut its FY25 revenue growth expectations to 5.4% from 7.2% earlier. Also, it’s not like valuations offer comfort. Lately, widely held expectations of interest rate cuts by the US Federal Reserve gave shares of export-focused Indian IT services companies a boost. But unless that hope actually materializes, it is better to keep expectations lower from IT sector earnings going into FY25.

Analysts from Dolat Capital Market believe TCS and other tier-I IT companies are likely to experience a few more quarters of subdued growth before there is any noticeable acceleration in growth. TCS trades at a rich FY25 price-to-earnings multiple of 25 times, showed Bloomberg data. This is highest among tier-1 peers and appears pricey amid the ongoing demand weakness.

After TCS’ mixed bag performance in Q4FY24, in the upcoming days, investor focus will be on FY25 revenue growth guidance by competitors Infosys Ltd and HCL Technologies Ltd.

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