BackTCS shares: Why Motilal Oswal sees potential upside despite Q1 profit miss
Motilal Oswal said TCS is well positioned to withstand the weakening macro environment and ride on the anticipated industry growth
PremiumDespite TCS reporting lower-than-expected profit and margin numbers, Motilal Oswal see potential upside in the stock. The domestic brokerage has maintained buy on the stock with target price of ₹3,730, a 14% upside potential from current levels. TCS shares are down about 13% so far this year, amid broader market correction and worries about global recession which could crimp IT spending.
Increase in interest rates, slow economic growth, and elevated geo-political tensions have impacted the macro environment and raised concerns over IT spends, say analysts.
Motilal Oswal says given TCS' size, order book, and exposure to long duration orders, and portfolio, it is well positioned to withstand the weakening macro environment and ride on the anticipated industry growth.
“TCS has consistently maintained its market leadership position and shown best-in-class execution. It allows the company to maintain its industry-leading margin and demonstrate superior return ratios," the brokerage said.
On Friday, Mumbai-based TCS reported that its net profit rose 5.2% to ₹9,478 crore in the three months to June 30, lower than analyst expectations of ₹9,851 crore. Operating margin for the quarter stood at multi-year low of 23.1%, down from 25.5% a year earlier, mainly due to the impact of annual salary increases, elevated cost of managing the talent churn and gradually normalizing travel expenses.
The attrition rate in the Indian IT services major was at 19. 7%.
“Wage hike in Q1 negatively impacted EBIT margins by 150 bps. Elevated attrition, all time high subcontractor cost and resumption of travel expenses also impacted margins during the quarter. Lower other income also resulted in lower net profit, down 4% QoQ," Motilal Oswal said in a note.
Rajesh Gopinathan, Chief Executive Officer and Managing Director, in his post-earning commentary said that as of now the IT major is yet to see any footprint of recession on the demand side but it remains watchful.
“Despite intact commentary, they indicated that the US will do better than Europe, due to client concerns over the slowdown. In our view, this is an initial sign of industry commentary turning more realistic vs the current view of no impact on tech spends. We are factoring in TCS revenue growth of 10.2% YoY in constant currency terms in FY23 (vs 15.5% in Q1), as the growth moderates in H2 FY23," Motilal Oswal said.
TCS expects margins to improve sequentially for the remaining quarters of FY23.
The brokerage said the drop in margins was “higher than our expectation, led by elevated salary hikes and subcontractor expenses. Given elevated attrition and TCS focus on growth, we expect EBIT margin in FY23 to decline 110 bps YoY to 24.2% (vs 26-28% medium-term guidance). TCS should start seeing some benefit in overall cost in FY23 with a fresher hiring of 100K in FY22."
Motilal Oswal said it has “tweaked FY23/FY24 EPS by 4% to account for lower margins. We expect a USD revenue CAGR of 9.3% over FY22-24 and INR EPS CAGR of 13.1% during the same period. Our target price of ₹3,730 implies 28 times FY24 estimated EPS, with a 14% upside potential. We maintain our Buy rating on the stock."
TCS shares technical outlook
Santosh Meena, Head of Research, Swastika Investmart Ltd, says TCS missed street expectations in Q1 earnings as margins are under pressure and the attrition rate is still high. “However, the TCS stock headed in its Q1 earnings with tepid expectations. Therefore, there is no knee jerk reaction expected while buying can be seen at lower levels," he said.
“Technically, the counter is still making lower highs and lower lows formation where a 50-DMA of 3333 is an immediate hurdle; above this, we can expect a short-covering rally towards the 3470-3500 zone. It has to sustain above the 3500 mark for any major buying interest. On the downside, 3200 is an immediate support level; below this, it is vulnerable to a fall towards the 3000 mark. However, ₹3,000 is a good level for fresh entry."
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