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TCS’s strong Q2 results show rally in IT shares was not unfounded

In the September quarter, revenues grew as much as 4.8% in constant currency terms and operating profit margin of 26.2% was the highest in the past eight quarters.ht (MINT_PRINT)Premium
In the September quarter, revenues grew as much as 4.8% in constant currency terms and operating profit margin of 26.2% was the highest in the past eight quarters.ht (MINT_PRINT)

  • Revenue grew 4.8% q-o-q in constant currency; operating profit margin of 26.2% was highest in 8 qtrs
  • TCS also announced a buyback at 3,000 apiece, which is at a near-10% premium to prevailing prices

When the pandemic-related lockdowns disrupted operations of companies across the world, Tata Consultancy Services Ltd had said that the impact of covid-19 is likely to be similar to that of the global financial crisis. But things are turning out to be far better than it had anticipated.

In the September quarter, its revenues grew as much as 4.8% sequentially in constant currency terms and operating profit margin of 26.2% was the highest in the past eight quarters. Some of this is driven by one-off factors, but even adjusted for those, the performance is far better than most estimates. IT stocks have already been rallying, on the back of large deal wins and positive commentary by firms such as Accenture Plc and HCL Technologies Ltd. TCS’s earnings surprise will only add legs to the rally. On New York Stock Exchange, Infosys Ltd’s shares were trading about 4% higher at the time of writing.

Bouncing back
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Bouncing back

TCS also announced a buyback at a price of 3,000 per share, which is nearly at a 10% premium to prevailing prices. This may only add to the excitement in the TCS counter, when trading resumes on Thursday.

“This recovery has strong legs going forward," Rajesh Gopinathan, chief executive officer, TCS, said in a press conference, while announcing the results. The company also talked of a multi-year cycle where the use of transformative technologies is expected to drive demand. While the use of digital and cloud services has been talked about for a while, the pandemic has resulted in a surge in demand for such services. “The deal pipeline is strong across all companies led by a mix of digital foundation, integrated deals from smaller clients, experience transformation and core transformation deals," analysts at Kotak Institutional Equities said in a 30 September note to clients.

TCS’s Q2 revenues got a boost from this improvement in demand as well, though some of the growth was a result of an improvement on the supply side. The lockdowns had impacted the supply-side in end-March and early-April for TCS, accounting for a fifth of the overall drop in Q1 revenues, Gopinathan had said, while announcing June quarter results. With the supply side issues now sorted, Q2 revenues would have got a boost of about 1.4%, said an analyst of a brokerage, seeking anonymity. Likewise, selling, general and administrative expenses were unusually lower in Q2, and it remains to be seen if the jump in margins is partly due to a one-off boost.

Also, TCS continues to lag peers, such as Infosys, on a year-on-year basis. Its revenues fell 3.2% in constant currency y-o-y, while Infosys’s revenues are estimated to rise 1%.

It’s little wonder that TCS shares are up about 22% from its pre-covid highs, while Infosys’s shares have rallied over 33%. Still, from an industry perspective, the key takeaway is that IT companies are doing reasonably well amid the pandemic.

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