Home / Markets / Mark To Market /  Why TCS’s Q2 earnings miss stands apart from previous downturns

There is a running joke in the financial markets about how earnings beats and misses are reported. “The company missed analysts’ estimates..." is the phrase that is typically used, whereas, in fact, it is analysts who would have missed earnings with misguided estimates.

As it turns out, there is an unusually large difference between analysts’ estimates of Tata Consultancy Services Ltd’s (TCS) earnings in Q2 and the actual reported earnings. While there is little doubt that analysts missed earnings by a mile, it also appears that the company missed some of its own internal estimates by a great extent.

Using consensus estimates compiled by Bloomberg, TCS was expected to report an operating profit of 9,933 crore. Instead, it reported earnings before interest and tax of 9,361 crore, which is almost 6% below the consensus estimate. “Such a large miss on earnings is rare; any variance of over 3% will trouble investors," said an analyst at a multinational brokerage firm, who declined to be named. In his books, evidently, the miss was on the part of the company. Either way, it is clear that the TCS stock will fall when trading resumes on Friday.

Graphic: Santosh Sharma/Mint
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Graphic: Santosh Sharma/Mint

TCS disappointed both in terms of revenue growth as well as on profit margins. The upshot: operating profit fell by 4.2% year-on-year, which is a rare occurrence in the company’s history. Quarterly data since FY07 shows that operating income has fallen on only two occasions in a period of over 50 quarters.

While revenues were expected to fall to single-digit levels in Q2, after four successive quarters of double-digit growth, hardly anyone, including the company, expected growth to fall to the reported 8.4% levels in constant currency. Q2 is considered to be a seasonally strong quarter, and growth rates typically pick up during this period. While there was continued weakness in the banking and financial services sector, as reported earlier by Accenture Plc., TCS’s revenues were also hit by a large drop in momentum in its retail and consumer packaged goods division. The uncertainty caused by factors such as the trade war and Brexit is impacting tech spending across various verticals.

The worry for investors is that apart from the drop in revenue growth rates, profit margins fell to a nine-quarter low. Typically, margins bounce back in Q2 when compared to Q1, which is when wage hikes and higher visa costs typically depress margins.

The company suggested in its post results commentary that it had positioned itself for higher growth, and that margins fell because growth was lower than expected. Margins are also lower because of higher costs in on-site operations, owing to the need to hire more locals in the US.

The silver lining for TCS shareholders is that cash generation has been robust and the huge dividend payout the company announced is a positive. Besides, since the stock has underperformed in the past month, at least there isn’t the burden of very high expectations.

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